press trumpets increases in business loans as a sign that better days are ahead. The housing market is viewed as a key driver of the overall economy, so increases in mortgage loans—which are roughly 70 percent of all consumer loans—are applauded as a sign of the resurgence of this market. Only increases in student loans (and to a lesser extent, credit card loans) are viewed with concern and not because of their impact on the economy, but because of a protective posture toward consumers.
Growth in private loans is generally a positive, but it is a central thesis of this book that such growth can become too high. If credit standards are relaxed and the result is that loans grow too rapidly and too much gets built or produced, that spells trouble.
While US private debt to GDP growth is currently flat, as shown in Charts 4a and 4b (which I refer to as the “debt snapshot”5), the crisis of 2008 came after the point where private loans to GDP had grown 20 percent in five years and total private loans to GDP exceeded 170 percent. (Debt snapshots for all the crises discussed in this book can be found in Appendix C.)
I wondered whether this was also true for the crash of 1929, a crisis for which an endless variety of explanations have been offered. When we reviewed the data, just as in the period before the Great Recession, we saw a pronounced acceleration of lending in the mid- to late 1920s. By 1928, private loans to GDP had increased almost 20 percent, and private debt to GDP reached a towering 161 percent (see Charts 5a and 5b). In fact, this was the first peacetime moment in US economic history when these two “twin peaks” of debt were reached simultaneously, and it was perhaps a time of far less sophistication and resilience in financial markets. Lending in the 1920s was directed more toward business borrowers than was true in the 2008 crisis. In the 1920s, loans poured out to finance skyscrapers, business acquisitions, cars, homes, radios, and much more. Whatever other causes might have contributed to the crash of 1929 and the Great Depression, the rapid run-up in debt was central to the story.
Given the centrality of increased private debt to both the 1929 and 2008 calamities, we looked at the two other largest crises of the last generation to see if private debt played a part there as well: Japan’s crisis of 1991, which followed its “economic miracle” of the 1980s, and the Asian crisis of 1997, which followed the “Asian economic miracle” of the 1990s. As shown in Charts 6a and 6b, in the period from 1985 to 1990, Japan’s private debt to GDP increased by 28 percent and reached 213 percent of GDP. And in the five-year run-up to the Asian crisis of 1997, private loans to GDP for South Korea and Indonesia grew 29 percent and 43 percent, respectively, and in South Korea, private debt to GDP reached 170 percent.
Runaway lending created the Japanese and Asian economic miracles, but those miracles brought crisis.
Though less pronounced, even the Reagan revolution of the 1980s was in part the result of a simultaneous debt surge in both private and public debt that by 1987 had resulted in 19 percent private debt to GDP growth and 41 percent government debt to GDP growth in five years. (See Appendix C.) This followed a thirty-year period ending in 1980 in which, importantly, a long decline in government debt to GDP and increases in private debt to GDP had largely offset each other. As we would expect from our private debt hypothesis, this Reagan-era surge in debt brought the crash of October 1987 and the savings and loan (S&L) crisis of the late 1980s and early 1990s.
Government debt to GDP was relatively benign before the crash of 1929, the US crisis of 2008, and both the Asian crisis of 1997 and the Japan crisis of 1991. In the United States, even with its Middle Eastern wars and a major increase in social program expenditures, federal debt to GDP was no higher in 2007 than it had been a decade before. The five-year increases in government debt to GDP in Japan in 1991 and South Korea in 1997 were both near zero.
In fact, the government debt to GDP ratio sometimes improves in the “runaway lending” period and becomes something of a contraindicator. In Spain, before its recent crisis, government debt to GDP declined by 16 percentage points. The credit boom brings increased income to businesses and consumers, and one result is more tax revenues for the government. Most businesses and consumers feel good, even euphoric, about their financial situation during this runaway lending period. And governments start believing they have found the recipe for economic success, such that the talk is often of economic miracles. But it shouldn’t be, because the other economic shoe is now dangling and threatening to drop.
From our analysis of these crises, our hypothesis is that for major economies, growth in private debt to GDP of roughly 18 percent in five years combined with an overall private debt to GDP ratio of 150 percent or more means that a crisis is likely.
In the United Kingdom, the 2008 crisis came after it had reached 24 percent private credit to GDP growth in five years and 208 percent total private debt to GDP. Judged by the standard of private debt that we are using, the United Kingdom reached worse conditions than the United States. (See Charts 7a and 7b.)
The eurozone—eighteen European Union member states that have adopted the euro (€) as their common currency—has a combined current GDP of $13.1 trillion. However, four countries alone—Germany, France, Spain, and Italy—compose 70 percent of eurozone GDP. Study those four countries, and you have a good sense of the whole.
Spain’s recent crisis came when it had reached private debt to GDP growth of 49 percent in five years and total private debt to GDP of 220 percent; France had reached 21 percent and 150 percent; and Italy had reached 33 percent and 118 percent. Of the four countries, Spain’s lending trends were by far the most egregious (see Charts 8a and 8b). Notably, Germany only reached 122 percent and had a decline in private debt to GDP of 10 percent, but it had a crisis nonetheless because it is so inextricably intertwined with the other eurozone countries. Combined, the four countries had 19 percent growth in private debt to GDP and 144 percent total private debt. Germany is almost a special case because its export rate is so extraordinarily high relative to other countries. In 2012, Germany’s exports to GDP were 52 percent, an enormous number compared to the United States’ 13 percent, France’s 27 percent, and Spain’s 32 percent. Even China—which we think of as a massive exporter—only exports at a level of 27 percent of its GDP. (Therefore Germany is, in some respects, just as dependent on its neighbors as they are on it, though few frame it this way.) Germany’s export dependence on other countries is so high that it is to some degree more useful to think of the eurozone as a single entity—economically at least—where a portion of the rise in private debt of other eurozone countries is to finance purchases from Germany.
As we have shown for other countries, government debt levels were benign and even improving in all these countries in large part because of the growth in private debt and the false prosperity that it brought.
Many of the countries at the periphery of the eurozone were and are in even worse shape. Note the debt snapshots of Greece, Portugal, and Ireland in Appendix C, with Greece’s private debt to GDP growth of 58 percent in five years leading to its crisis. Portugal and Ireland’s current private debt levels are 250+ percent and 300+ percent, respectively, and hang like millstones around their economic necks.
