Determining why economies act the way they do is often elusive because it is so difficult to conduct controlled experiments. There are no laboratories, no test tubes, in which whole economies can be manipulated and studied. But the 2008 financial crisis provided economists with the next best thing: A crisis striking nearly everyone on the globe. This opened a window that allows us to see how different nations reacted to, and recovered from, a similar financial shock in real time.
The August 2013 gross domestic product report by the US Bureau of Economic Analysis drew little attention, but it contained a fairly remarkable piece of data: Inflation-adjusted GDP per capita in the United States hit a new all-time high in the second quarter of 2013, the first time a new high had been reached since 2007. Real consumer spending has hit a new high, too, and auto sales are at levels not seen since before the financial crisis. Millions of Americans are still searching for work and suffering financial hardship, but on average, by the broadest measures of economic performance, America’s Great Recession is over.
Few nations across the Atlantic can say the same. The Eurozone slipped back into recession in 2012 for the second time in four years, and remains in an economic state that can be accurately described as miserable. Real economic output among Eurozone nations remains three percentage points below its 2008 peak. Eurozone unemployment sits near twelve percent in late 2013, higher than the US ever experienced at the peak of its recession. These problems are as deeply human as they are economic or political. Each percentage point rise in Europe’s unemployment rate has boosted its suicide rate by 0.79 percent, according to a study published in the medical journal the Lancet.
Why America’s economy has recovered while Europe remains stuck near recession is largely a factor of two forces: Europe by and large chose the path of fiscal austerity while America chose stimulus, and America also has control over its own currency, while member states under the euro currency do not. Most economic analyses of the last four years begin and end there, concluding that the dual force of fiscal contraction and monetary skittishness has unreasonably slowed Europe’s recovery and cost its economy dearly.
Recently, Oxfam International estimates austerity across European governments could leave twenty-five million of its citizens in poverty by 2025. But the situation is far more complex than can be explained by economic politics alone. Two other specific factors are also particularly persuasive in explaining the economic chasm between America and Europe: the deleveraging of household debt, and demographics. Understanding the role of deleveraging in the current economic landscape begins with a brief look back at the aftermath of World War II, the crucial moment in the modern world’s relationship with debt.
According to Spike Peterson, an Associate Professor in the Department of Political Science at the University of Arizona, the Great Depression of the 1930s left American policymakers bewildered and worried. When the war ended in 1945, a prevalent fear arose that the economy would slip right back into depression. In 1947, the Council of Economic Advisers warned President Truman of “a full-scale depression sometime in the next one to four years.”
Spike Peterson further noted that, policy was needed to combat this risk. But with Europe and Asia devastated, exports couldn’t be relied on to fuel American growth. The country was on its own. The millions of soldiers demobilized from war would be turned into heavyweight consumers. Mortgage rules were relaxed, interest payments became tax deductible, and new lending programs made consumption more attractive.
As a result, spending boomed after the war, fueled in great part by debt. Spike Peterson stated that household debt grew sevenfold between 1949 and 1968, from USD 60 billion to more than USD 400 billion. Surging consumption led to an economy that was thriving and sustainable. While household debt rose in the 1950s and 1960s, so did the average American’s income, so much so that debt-to-income ratios rose only modestly through the 1970s.
Morgan Housel, a noted economic analyst in Washington stated that, the 1980s brought a new status quo. Debt continued to grow, but income growth languished and then plunged for most American households. The economy prospered tremendously during the 1980s and 1990s, but the majority of gains were concentrated in a small percentage of households. Most consumers saw little real income growth.
While average incomes stagnated, however, the average desire for material goods did not. With legitimately rich Americans raising the expectations and aspirations of their lower-income peers, this less fortunate sector of the economy, unwilling to cut back on consumption, had to rely on higher household debt to maintain household spending growth. Lending standards went from lax to absurd.
Alan Greenspan, the former Chairman of the US Federal Reserve, stood before Congress early in 2002 noted sarcastically that “children, dogs, cats, and moose are getting credit cards.” He stated that household debt-to-income ratios were sixty-five percent in 1980, ninety percent by 2000, and more than one hundred and twenty percent by 2007, when they peaked and sent the economy into the Great Recession.
Morgan Housel explained that it may appear that nothing has changed, but America has actually spent the last six years diligently dealing with its debt bubble. As the US Bureau of Economic Analysis 2013 report revealed that household debt has declined by nearly $1 trillion since 2008. As a percentage of GDP, household debt has shrunk from more than one hundred percent in 2009 to less than eighty five percent in 2013. Most of this debt was wiped away through default, as borrowers who stood no chance of repaying mortgages for which they barely, if at all, qualified walked away from their homes. But Americans also found the will to repay chunks of debt.
According to Morgan Housel, the personal savings rate surged from near zero percent in 2005 to more than seven percent by 2011. The number of Visa credit cards in circulation actually fell between 2009 and 2011, the first decline in history. Combine this retrenchment with mortgage refinancing at record-low interest rates, and the progress becomes nothing short of extraordinary. Household debt payments as a percentage of disposable income have plunged to the lowest level in more than thirty years. Our half-century addiction to consumer credit has come to a sudden and dramatic end.
Europe, however, has surprisingly enjoyed no such progress. The recent IMF data revealed that aggregate household debt to GDP among Eurozone nations was higher in early 2013 than it was in 2008, before the credit crisis began. The lack of progress is widespread across the region. German and UK households saw a mild deleveraging from 2008 to 2011, but household debt-to-income ratios in France rose from seventy-five to eighty-three percent, in Italy from fifty-eight to sixty-five percent, in the Netherlands from two hundred and forty-nine to two hundred and sixty-six percent, and in Ireland from two hundred and nine to two hundred and twelve percent.
European household debt to GDP has historically been well below that of the United States. Now we have traded places; European households are more indebted than Americans. Why American households have deleveraged while European debt burdens continue to rise is the main point of discussion for next time.