While politicians and the media continue to clamor for reductions in the federal deficit, private indebtedness in the United States has quietly grown to alarming and potentially threatening proportions. It's time we paid attention to the private sector's balance sheets as well as the public's.
It is most useful to categorize the private-sector books into three principal groups: corporate, household and farm. Corporations go into debt when they borrow to help finance either productive investment or paper investments, such as mergers and acquisitions. Households spill red ink when they undertake home mortgages or make purchases on installment credit. Farms incur new debt when they borrow to help finance production costs (usually at the beginning of planting) or new investment in structures, land and equipment.
All three groups have been running up debts in record proportions.
Corporate borrowing by itself is neither good nor bad; what matters is the relationship between borrowing and the flow of income with which firms can cover interest charges and amortization of principal. If debt piles up as earnings increase, the indebtedness may be perfectly healthy, helping to finance expansion. If the ratio of debt to retained earnings is rising, however, a firm's finances may be teetering due to excessive debt.
What makes sense is to look at real corporate debt in relationship to net after-tax corporate profits. By these standards, it appears that corporations are beginning to get into trouble.
Real industrial and commercial loans outstanding have increased by nearly 40% during the recent business cycle expansion (from 1982 to third quarter 1986), reaching levels nearly 60% higher than in the last business cycle peak in 1979. The ratio of business loans outstanding to net after-tax profits had climbed by third quarter 1986 to a level last equaled in 1973, just before the huge recession of 1974-75 and the rash of bankruptcies which accompanied it.
By now, although the data for December, 1986, or early January, 1987, are not available on a consistent basis, this measure of corporate indebtedness has undoubtedly reached a new high for the period since World War II.
Record Borrowing Binge
Households are also borrowing at record levels. Again, it makes sense to look at consumer borrowing in relationship to the money with which households can cover interest and principal repayment.
If we compare real consumer installment credit outstanding with household personal income, we find that households had run up installment credit debts in the third quarter of 1986 equal to 16.5% of total personal income. This measure of household indebtedness set a new postwar record, almost 20% higher than the previous postwar peak in 1979.
The farm debt crisis is already well-recognized. If we compare total farm debt to net farm income, that index of farm indebtedness had already reached postwar record levels by 1984, and it continues to soar.
The farm credit system is gasping for life, with both the Farm Credit System and the Farmers Home Administration holding on to billions of dollars of bad loans. We can't keep deferring the farm debt crisis forever. "Collateral declines and losses grow," a farm credit administrator recently observed. "Loss deferral doesn't work."
How big are these private-sector debts combined?
We are used to thinking that the federal government's debt is astronomical--now at a scale which we can scarcely imagine. Total government debt has now reached about $2 trillion.
But total private-sector debt is roughly 2 1/2 times as large: In the third quarter of 1986, corporate debt was $1.6 trillion while household debt reached $2.5 trillion, farm debt $167 billion and other individual debt $768 billion. The total came to a hair under $5.1 trillion.
But again, what matters about debt is its size relative to our ability to carry it. We have learned, at least in some of our less frantic moments, to compare the size of the federal debt to the level of gross national product. We should similarly compare the size of total private-sector debt to the flow of goods and services which can cover its interest and repayment--that is, to total gross national product.
These comparisons should give pause to even the rosiest of economic optimists. Total private-sector debt, by the third quarter of 1986, had climbed to 1.2 times the total size of gross national product. Although the data is a little difficult to compare historically, this is clearly a postwar record, by far the highest level of relative private indebtedness since the period after World War II, when we began to borrow to help finance rapid economic expansion.
More staggering still, it appears that this index of relative private indebtedness has climbed to levels higher than the peak of the Roaring '20s--reaching the heights of 1929 just before the crash which plunged the U.S. economy into the Great Depression.
Should we care?