RESEARCH
REPORTS
Published Weekly by
AMERICAN INSTITUTE
for ECONOMIC RESEARCH
Great Barrington, Massachusetts
Vol. XLVI No. 3
01230
January 15, 1979
Household Debt
Large increases in consumer and mortgage debt during
this business-cycle expansion have raised the burden of
U.S. household, debt to its highest level in history. This,
together with recent signs of moderation in the rate of
increase in both mortgage debt and consumer installment
debt almost ensure that the contribution of household
expenditures to general economic activity will diminish. A
cyclical contraction in household debt accumulation
already might have begun, but the evidence does not yet
clearly indicate so. Credit availability might have to be
further restrained and interest rates might have to rise
substantially more before such a contraction occurs.
Large increases in spending by the household sector of
the economy have provided the major impetus thus far
during the current cyclical expansion of general business
activity, as investment by businesses and the amount of
Government purchases of goods and services have increased
only moderately. However, households borrowed heavily to
finance those purchases, and this has raised concern about
their capacity to maintain a rate of consumption
expenditures adequate to support continued economic
expansion or even to repay already incurred debt on
schedule. Because household expenditures account for
about two-thirds of Gross National Product (GNP), a
substantial reduction in the rate of household borrowing at
this stage of the business cycle well could precipitate a
cyclical contraction of general business activity.
Debt of U.S. households is compiled by the Federal
Reserve and published in its quarterly "Flow of Funds"
reports. In the accompanying table we show the amount
of U.S. household debt outstanding as of the third
quarter of 1978 by type of debt. Home mortgage debt
and consumer installment and noninstallment credit
account for about 85 percent of total household debt;
therefore, in this discussion on the implications of the
household debt burden we focus on those components.
HOUSEHOLD DEBT OUTSTANDING, BY TYPE
Billions of $ % of total
100.0
1,104
Total
96.0
1,060
Credit Market Instruments
Home mortgages
Other mortgages
Consumer installment credit
Other consumer credit
Bank loans n.e.c*
Other loans
679
27
233
44
Amount of Borrowing
Since the cyclical trough of business activity in early
1975, U.S. households have accumulated more debt than
during any comparable period in the Nation's history.
During this cyclical expansion, the total amount of
household debt outstanding has increased at an average
rate of 13.9 percent, or about $103.4 billion, per year. Of
that total, home mortgages have accounted for the largest
share of net new borrowing. Net home mortgage
borrowing increased markedly to successive record
amounts of $61.3 billion and $93.0 billion during 1976
and 1977, respectively, up from $38.1 billion in 1975.
The previous record amount of $47.1 billion was reached
during 1973. Net mortgage borrowing during the first 3
quarters of 1978 was about equal to that during 1977;
however, the trend in such borrowing was upward during
1977 but downward during 1978.
Chart 1 shows trends in net home mortgage borrowing and expenditures for new and existing homes.
The chart reveals not only the astonishingly large
increase in the amount of mortgage borrowing since
early 1975 but also the substantial margin by which net
mortgage borrowing of households has exceeded capital
outlays for conventionally built new and existing homes
during the past 2Vi years. An excess of net mortgage
borrowing occurred only one other time during the
postwar period, from early 1972 through mid-1974. But,
as Chart 1 shows, the total excess then was much
smaller than during the recent episode. Obviously,
households as a group have borrowed against equity in
existing homes for much of this expansion, thus freeing
funds for uses other than the purchase of new homes.
However, the chart also reveals that such borrowing
against house equity peaked in the third quarter of
1977 and subsequently diminished markedly. During the
third quarter of 1978, the excess was $1.05 billion,
Chart 1
HOUSEHOLD CAPITAL EXPENDITURES ON HOMES
Billions. AND NET MORTGAGE BORROWING^
$120
61.4
2.5
21.1
4.0
40
3.6
37
22
13
10
3.4
2.0
1.1
0.9
Security Credit
Trade Debt
Miscellaneous
* Not elsewhere classified.
Note: Components may not add to totals because of rounding.
Source: Federal Reserve Board.
0
1960
'65
70
75
Note: Data are seasonally adjusted amounts borrowed and expended (luring the quarter at annual rates.
about one-sixth that during the peak quarter a year
earlier.
Household borrowing in consumer credit markets also
has increased markedly during the current cyclical
expansion of general business activity. The total of net
consumer installment and noninstallment borrowing increased $23.5 billion during 1976 and a record $35.1
billion during 1977, up from $9.4 billion during 1975. The
previous record net increase in consumer credit was $23.8
billion during 1973. During the first 3 quarters of 1978,
consumer credit increased at a net average annual rate of
about $44.3 billion, thus suggesting another probable
record increase of this series during 1978. However, as we
described in Research Reports of December 25, 1978, the
percent change in consumer installment borrowing, which
accounts for over 80 percent of total consumer credit, has
trended downward during the 5 most recent months. This
indicates that, although consumer installment debt still has
been increasing, there is a 50-50 chance that it already has
begun to decrease cyclically rather than merely temporarily.
series and includes noninstallment as well as installment
debt, the 50-percent chance of a cyclical contraction
referred to above is not apparent in this chart. In spite of
this, the downward trend in the rate of increase in
mortgage borrowing since the third quarter of 1977 was
large enough to cause the rate of increase in total
household debt to trend clearly downward since then.
The current downward trend in total household debt
increases suggests at least a moderation in business activity,
but it does not necessarily portend an imminent business
recession. Note the prolonged and large decrease in the
total series during the mid-1960's, a period having a
"mini-recession" but not a bona fide cyclical contraction.
Household Debt Burdens
The burden of household debt can be measured by
relating net borrowings, amounts of debt outstanding, and
volumes of debt repayments to disposable personal
incomes, for it is out of such income that debt usually is
paid. Chart 3 shows these relationships.
The top section of Chart 3 shows net credit changes, or
flows, in relation to disposable personal income. This
measure reveals the rate at which households currently
have added to their eventual debt burden in terms of
their current ability to pay it. This ratio for total credit
flows to households reached a record high during the
second quarter of 1977, but it trended moderately
downward during the subsequent 5 quarters. As shown,
the principal factor in the large increase in debt burden
has been home mortgage borrowing, and as such
borrowing has tapered off, so has the current increase in
the eventual burden.
But the debt that households eventually must repay is
not just the increase currently incurred. It is that, plus
the amount previously incurred, or the total outstanding.
The eventual burden of the totals outstanding in relation
to current disposable income is shown in the middle
section of Chart 3. Because of the unusually large volume
of mortgage borrowing since early 1975, the ratios of
both mortgage and total household debt outstanding to
disposable income have increased markedly to new highs.
Outstanding consumer credit in relation to income also is
a record, but only slightly above the earlier peak levels of
1973 and 1974.
The high level of and continuing increases in these ratios
have been cited by many analysts who are concerned about
the ability of the household sector to pay its debts. But all
of this debt is not due immediately. If inflating continues
and nominal incomes rise in general, the amount of current
debt outstanding in relation to the future amount of
incomes to pay it may be much smaller than it is in terms
of current incomes. Indeed, heads of many households
probably are relying on this development.
If many are, any substantial moderation in general
price and wage increases probably would be accompanied
by a sharp cutback in household borrowing and spending,
as heads of households would attempt to bring the
eventual debt burden in line with the then-new outlook
for future incomes. Widespread cutbacks in spending
could mean recession, unemployment, and decreases in
incomes, making more burdensome — perhaps unmanageable — the current burden of carrying the debt.
The current burden of debt is only the portion
currently due in relation to income currently available for
making the payments. The ratios of debt repayments to
disposable income are shown in the bottom section of
Chart 3. In spite of a general lengthening of loan
maturities and rising current-dollar disposable incomes,
Chart 2 shows percent changes in the major types of
household debt outstanding. The chart reveals that
although mortgage debt outstanding, consumer debt
outstanding, and total household debt outstanding have
continued to increase through the third quarter of 1978,
the rates of increase in all three series have decreased.
Because the consumer debt series in Chart 2 is a quarterly
Chart 2
PERCENT CHANGE IN
HOUSEHOLD DEBT OUTSTANDING
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1960
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Note: Quarterly data, seasonally adjusted.
10
repayments on mortgage debt, and total household debt
in relation to such incomes are record highs, and the ratio
for consumer debt is near the record high. In the third
quarter of 1978, 20.9 cents of every dollar of disposable
personal income was claimed for household debt
repayment. A year earlier, the amount was 19.6 cents, the
same as the previous record high in 1969 and 1970.
lending institutions into higher-yielding investments as
mandated interest-rate ceilings for thrift institutions are
exceeded.) Government regulations now permit thrift
institutions to issue special 6-month certificates paying a
quarter-point more than the prevailing 6-month Treasury
bill rate. This change has enabled thrift institutions to
obtain adequate supplies of mortgage money as interest
rates have risen. At this writing, monetary officials seem
reluctant to allow interest rates to increase further, but it
may take much higher interest rates than peak rates
during previous cycles to reduce mortgage borrowing
substantially.
Moreover, due to rapidly increasing housing prices,
household equity in existing homes has increased
markedly during recent years in spite of the borrowing
against this equity referred to earlier. According to
estimates by the Federal Reserve, housing equity available
to serve as potential collateral for additional mortgage
borrowing exceeded $900 billion at the end of 1978 —
about double the amount estimated for 1970. Thus,
although mortgage debt outstanding now appears large by
historical standards, there still exists a huge potential for
further mortgage borrowing to finance house purchases on
resales or to finance other purchases.
In our view, the recent downward trend in the rate of
increase in household debt accumulation and the current
record burden of household debt have the potential for
initiating or aggravating a business-cycle contraction.
However, a more moderate rate of increase in household
debt also appears sustainable for some time. Therefore,
we do not agree with those who conclude, on the basis of
household debt data, that a recession is imminent. But we
do believe that continued increases in the burden of
household debt would signal heightened distortions of the
economy — distortions that eventually would be removed
with a more severe recession. The earliest useful
indication of when a recession will occur probably will be
given by our statistical indicators of business-cycle
changes, which currently suggest that a continuation of
the cyclical expansion is somewhat more probable than
the beginning of a contraction during the next few
months.
The Outlook
The rise in interest rates through the third quarter had
little effect on household borrowing, as the net increase
in such borrowing remained large, albeit somewhat less
than the recent peak. Because of the longer maturities
involved, the levels of monthly mortgage payments are
affected much more by increasing interest rates than are
the levels of monthly payments for consumer loans. At
some level, rising mortgage rates undoubtedly will choke
off mortgage borrowing. However, during past episodes of
rising interest rates, disintermediation was the major
factor in reducing mortgage borrowing by curtailing
supplies of loanable funds for mortgages. (Disintermediation refers to the flow of funds out of mortgageChart 3
SELECTED HOUSEHOLD DEBT TO
DISPOSABLE PERSONAL INCOME RATIOS
+12
+8
+4
total
CHINA: TWO LEGS BETTER?
+50
The new policies of the Chinese rulers seem to be an
improvement over the self-destructive "cultural revolution" of Chairman Mao, but many imponderables
remain, particularly concerning the future of Taiwan.
With all the hoopla, Americans should remember that
China remains a very poor nation and that the power of
the present regime continues to be derived from "the
barrel of a gun." The rule of law is not the nature of
totalitarian governments, and it would be miraculous if
the recent changes result in increased freedom or security
for any but a small, if somewhat enlarged, elite.
\ Mortgage
+30
Consumer
At the conclusion of Animal Farm by George Orwell
(Eric Blair), the animals' slogan, "four legs good, two legs
bad," was changed overnight. The following morning the
slogan read, "four legs good, two legs better," and the pig
leaders began to walk on their hind legs and to wear the
clothes left behind by their former human masters.
Recent changes in China have been almost as sudden.
The Chinese authorities appear to have reversed many of
the more destructive policies adopted during the "cultural
revolution" and continued during the last years of Mao's
rule. These moves reportedly include a restoration of
+8
1960
'65
'70
Note: Quarterly data, seasonally adjusted.
'75
11
performance for apparent fidelity to an ever-shifting
"party line" and to provide them with an increase in
material rewards — better clothes, hairdos, and even
Coca-Cola.
Although the recent developments are welcomed, we
should remember that the power of the Peking regime
still is derived from "the barrel of a gun," in Mao's
words. Unless they replace the rule of men with the rule
of law, the Chinese leadership would seem to be following
the example of the pigs in Animal Farm rather than the
road toward freedom and human rights.
academic standards in education, the introduction of
incentives in production, and a general de-emphasis of
some of Mao's less popular policies, such as required
manual labor for all segments of Chinese society. At the
same time, many formerly purged officials have been
"rehabilitated," and contacts with foreigners have been
increased. The most celebrated of the latter has been the
"normalization" of relationships with the United States,
including full diplomatic relations and an expansion of
trade. There are, of course, countless imponderables in
these developments, not the least of which is the future
of our longstanding ally, Taiwan.
Despite (or perhaps in large part because of) nearly 30
years of totalitarianism and central planning, China
remains a desperately poor country. Roughly 80 percent
of its vast population remains engaged in subsistence
agriculture, and the specter of famine is ever-present.
Most productive activity still involves considerable application of human muscle power, as energy supplies are
unreliable and scarce. Physical distribution systems
reportedly range "from the inadequate to the primitive."
It is improbable, therefore, that mainland China soon will
have the means to become a major trading partner of the
United States, without the U.S. lending China the funds
to buy U.S. products. Of course leading private bankers
would like to make those huge loans and leaders of major
businesses would like to make huge sales to China. We
should not suggest that they be denied those opportunities. But if they do transact with China, under no
circumstance should the political representatives of
American taxpayers "guarantee" either the loans or the
investments. If our sudden change in "China policy"
ultimately results in selling Taiwan "down the river," the
implications for our relations with other small nations
who have looked to us for security, notably Israel, are
ominous. We leave this question for clarification by
political analysts and by future events. Our purpose here
is to remind readers of the nature of the regime in China
and to suggest a possible explanation for the recent steps
toward "liberalization" there.
WHY NOT AN INVENTORY OF U.S. GOLD?
On December 20, 1978, the U.S. Treasury disclosed
that 5,200 ounces (worth about $1.1 million) or more of
the Nation's gold stock was missing from its New York
Assay Office. The revelation was not important for its
size (the total reported U.S. gold stock is about 276
million ounces) but for the admission of lax procedures
making such a loss possible. This event stresses the need
for a complete physical audit of the U.S. gold stock kept
at the New York Assay Office (reportedly about 55
million ounces) and the U.S. gold depository at Fort
Knox, Kentucky (the balance of the 276 million ounces).
For nearly 5 years, Mr. Edward Durrell has struggled
valiantly, but thus far unsuccessfully, to have the
Government conduct an indisputable inventory of the
Nation's gold stock, including the opening and testing of
the contents of all vault compartments reportedly
containing gold. According to Mr. Durrell, such an
inventory has not been taken since 1953! Because of the
duration since the last inventory, good practice alone
would seem to justify an inventory. But Mr. Durrell now
especially wants an inventory because of the persistence
with which officials have refused to conduct one. We ask,
Why not an inventory of the U.S. gold stock? It is long
overdue.
Mr. Durrell suggests that concerned Americans write to
President Carter, their Senators, and their Representatives
requesting such an inventory. More information can be
obtained by sending a self-addressed, business-size
envelope with 54 cents postage to Mr. Durrell at P.O. Box
586, Berryville, VA 22611.
There are no human rights in China. The portion of the
fruits of his labor that an ordinary citizen may claim,
where one may work, study, or travel, and what one may
say are all determined by the whim of the rulers. Some
citizens may be disadvantaged simply because they, their
parents, or their grandparents are considered "class
enemies." The road to personal advancement lies not in
serving the needs of one's fellow citizens, but in
cultivating the favor of the "powers that be."
The recent increase in freedom of expression may be a
trap for dissidents who will be "liquidated" at some
future date. This happened during the late 1950's after
the "let a hundred flowers bloom" period. In any event,
the clamoring for "democracy" seems not to reflect so
much a desire for the development of a "loyal
opposition" that might be capable of toppling the present
rulers in a peaceful election as a desire by middle-level
functionaries for security and increased personal consumption. Such persons are the most vulnerable to
arbitrary changes in policy. Unlike ordinary peasants, they
have something to lose, and they are the usual scapegoats
when ambiguous directives from above are rejected by the
masses. Moreover, the support of the middle level
probably is needed by the present leaders until their
power is consolidated.
Thus the recent changes may be designed to increase
the personal security of the middle level of Chinese
society by substituting consistent methods of evaluating
COMMODITIES PRICES
7978
1979
Index
Jan. 3 Dec. 26 Jan. 2
Spot-market, 22 commodities* 556
655
653
Commodity-futures
707
794
805
Steel-scrap
$69.83 $92.50 $94.17
1978
1979
Jan. 12 Jan. 4 Jan. 11
Gold
$173.55 $223.15 $220.65
*For the preceding Tuesday.
Note: The indexes are, respectively, those of the U.S. Bureau of
Labor Statistics, Dow-Jones, and Iron Age. The spot-market and
futures indexes are converted so that their August 1939 daily
averages equal 100. The steel-scrap index is a composite price for
No. 1 heavy melting scrap. The gold price is the final fixing in
London.
Research Reports (ISSN 0034-5407) (USPS 311-190) is published
weekly at Great Barrington, Massachusetts 01230 by American
Institute for Economic Research, a nonprofit, scientific,
educational, and charitable organization. Second class postage paid
at Great Barrington, Massachusetts 01230. Sustaining membership:
$9 per quarter or $35 per year.
12