As Goes The Credit Market, So Goes The World

During the prior economic cycle of 2003-2007, one question I asked again and again was: Is the US running on a business cycle or a credit cycle?

That question was prompted by a series of data I have tracked for decades; data that tells a very important story about the character of the US economy. Specifically, that data series is the relationship of total US Credit Market Debt relative to US GDP.

Let’s put this in simple English. What is total US Credit Market Debt? It's an approximation for total debt in the US economy at any point in time. It’s the sum total of US Government debt, corporate debt, household debt, state and local municipal debt, financial sector and non-corporate business debt outstanding. It's a good representation of the dollar amount of leverage in the economy.

GDP is simply the sum total of the goods and services we produce as a nation.

So the relationship I like to look at is how financial leverage in the economy changes over time relative to the growth of the actual economy itself. Doing so reveals an important long-term trend. From the official inception of this series in the early 1950’s until the early 1980’s, growth in this representation of systemic leverage in the US grew at a moderate pace point to point. But things blasted off in the early 1980’s as the baby boom generation came of age. I find two important demographic developments help explain this change.  

First, there's an old saying on Wall Street: People don't repeat the mistakes of their parents. Instead, they repeat the mistakes of their grandparents. From the early 1950’s through the early 1980’s, the generation that lived through the Great Depression was largely alive and well, and able to “tell” their stories. A generation was taught during the Depression that excessive personal debt can ruin household financial outcomes. Debt relative to GDP in the US flat-lined from 1964 through 1980.  As our GDP grew, our leverage grew in commensurate fashion. We were living much closer to our means compared with what happened afterwards.

In contrast, from the early 1980’s onward, we witnessed an intergenerational change in attitudes toward leverage. Grandparents that lived through the Depression were no longer around to recite personal stories. The Baby Boom generation moved to the suburbs, bought larger houses, sent the kids to private schools, financed college educations with home equity lines of credit, and carried personal credit balances that would have been considered nightmarish to their grandparents. What was the multi-decade accelerant that sparked this trend of ever-increasing systemic leverage relative to GDP?  Continuously lower interest rates for thirty five years -- falling to a level no one ever believed imaginable, grandparents or otherwise. Which is where we find ourselves today:

My underlying point: Increasing leverage has been responsible for total US economic growth for over 30 years.

And don’t let the slight decline in the last years of this series fool you. While the ratio of US total debt relative to GDP has fallen since the peak of 2008, in absolute Dollar terms, US total credit market debt has actually increased from $50 to near $60 trillion over this time. The numbers have just become so big that a $10 trillion increase over 7 years is now actually a 'taper'(!):

A lot of the taper came in the form of defaults on mortgages and corporate debt seen in the wake of the 2008 crisis. But, US Federal debt has grown from $8 trillion to close to $18.5 trillion since January 1, 2009, very much offsetting the deflationary pressures of such private sector debt defaults. Back to my main point: credit expansion has been a key support -- indeed, the most important one -- to the real US economy.

Why shout about this now? Two important, timely reasons.

First, we know the US Fed will need to raise interest rates. The bottom line is the Fed will be perceptually powerless if we enter the next recession with the Fed still at the zero bound. We’re now six years into this economic 'recovery' and yet interest rates just marked their seventh year at 0%. Hard to believe, but it has actually been 11 years since the Fed last raised rates. Although Wall Street is obsessing over when the Fed will start hiking them, I’d suggest the much more pertinent question is: Has the Fed waited too long? The answers to both of these questions lays ahead, but when we're talking about the Fed raising interest rates, we're talking about the repricing of credit inside the US financial system. If you believe, as I do, that credit is indeed the one big horse that has powered our economic growth over the last three decades, then anything that acts to reprice that cost of credit -- repricing in a manner that will handicap continued credit expansion -- will have direct and immediate repercussions on our economy.

Second, the current trend in a critical but oft-overlooked indicator of US credit conditions is flashing a yellow light.

In Part 2: The Central Banks Are Losing Control Of The System we analyze the cautionary alarm the data in the NACM Credit Managers Index is sounding, and note the increasing evidence that the central bankers are becoming increasingly panicked about losing control of the bond markets.

The stock market is a sideshow. It’s the credit markets where we see the most extreme bubble. It’s the credit markets that have danced most vigorously to the pied piper Central Banker music of the last six years, which is why we are watching them closely. When confidence in the Central Bankers finally cracks, I believe this is exactly where we'll see it first. And it’s this loss of confidence that will mark the decisive turn in the cycle for credit.  

Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

This is a companion discussion topic for the original entry at

In an earlier comment I talked about how capital flows cause price movements in the market.
For an economy, money flows both enable and in some cases create economic activity.

Think of it this way.  If credit isn't growing, then the only money flowing through the economy is (more or less) the wages everyone is earning - withdrawn from company bank accounts, deposited into worker accounts, and then spent back into the economy ending up right back in the company bank accounts again.

But if some economic actor goes and borrows an extra trillion dollars and spends it into the economy, then aggregate economic activity for the current period rises by at least one trillion dollars - more, if the initial receivers of the trillion don't sit on the money but instead decide to spend it on things they want to buy too.

Credit growth - at least for people - ends up adding to the current year's GDP number, which every politician likes because it creates jobs and everyone feels more wealthy, and they get re-elected.

So a constantly growing debt results in a constant injection of new money in excess of what the baseline economic activity would have provided.  How much new money?

Naturally I have a chart.  Example: in 2008, the "Money added to US economic activity through borrowing" was 4.43 trillion dollars.  That is, 4.43 trillion dollars of economic capital flow came directly from some actor (government, household, or corporate) borrowing money and then (presumably) spending it into circulation.  Given that GDP at that time was about 14.8 trillion, one could posit that a huge chunk of that year's activity came directly from the contribution of borrowed money.

So once that went into reverse in 2010, and 600 billion per year was sucked out of the economy that year instead, the swing from a +4.4 trillion to a -600 billion was a massive 5 trillion dollars difference.  That, in a 15 trillion dollar economy.

Next chart: this shows the change in TCMDO (money injected into the economy by new borrowing) divided by the total GDP for that year.  Its a rough measure of "the contribution of debt growth to GDP" per year.  We can see that debt growth is absolutely required to keep us in the lifestyle to which we have become accustomed.  But please, don't look at the balance sheet effects (TCMDO), only look at the income statement (GDP).

During the big debt days of the bubble, we were are used to getting 15-25% of our GDP from new debt every year.  Now that its only 10%, "we can't get liftoff" in our "recovery."  Just imagine if new debt was at 0%.  We'd lose 10% off our GDP, instantly.

Now project what happens if we start paying down our debt.  OMG.  Double down on that recession!  That's what Greece has been doing for the past six years.  And guess what happened to their economy?  -25% to GDP.

Credit growth is key.  Perhaps the key.

Note: not all components of TCMDO end up affecting the economy equally.  Money borrowed for home purchases end up pumping up home prices; money borrowed for equity market purchases pump up equity prices.  Money borrowed for autos and on credit cards cause general consumer inflation.  Money borrowed by banks to engage in speculation pump up speculative assets.  And so on.  As a result, the chart above is an over-simplification.  But from a rough money flow sense, it is accurate; an extra 4.4 trillion added to a 15 trilion dollar economy turns out to be a big deal, as is subtracting 600 billion from that same economy.

Trillions have been injected into the economy, yet the velocity of money is near a 50 year low. The money is flowing into the hands of the already wealthy, bonuses for corporate executives resulting from corporate stock buy backs increasing P/E ratios, and those at the bottom of the economic scale are not getting anything from the so called trickle down effect. Lots of low paid part time and minimum wage jobs to be sure. In order to keep things going, car loans for example are now going out as far as 84 months, a record. This has goosed car sales, but I wonder how credit worthy those borrowers are. If we enter into another recession, which seems likely, how many of the credit bubbles will burst? Student loans, car loans, oil shale debt? So if the bubbles begin to burst, will the Fed create more liquidity to save the banks? Is there not a point where the credit load becomes to high?

The unfortunate aspect of our debt based money system is that it needs to perpetually inflate or it collapses.
Perhaps that's not mathematically, precisely required in a perfect world where stocks and flows are exactly balanced, but in history that has seemed to be the case.  I think that the extent to which credit is simply used to leverage speculative positions, and not increase actual production, adds to that inflate/crash dynamic.

to that mix, I would add the recent trend of corporations borrowing heavily to buy back shares.  This is a form of leverage on future production, especially since that behavior has come with the absence of investment in capex.

Our whole society is now enthralled by the easy money spectacle on display, it is worshipped at a higher level than honest hard work, actual production, or solid science.  Just look at who is given the most airtime, the most respect, the most sought after … I mean what else to make of the fact that someone paid $2.3 million to have lunch with Warren Buffet while a similar auction for lunch with any of the world's most eminent scientists might go for a few thousand, if that? 

At any rate, we live in a system that, to my eyes, appears to need to inflate or it crashes.  And that rate of inflation, as Dave's charts admirably show, yields the most stable system when credit is growing by several multiples of actual economic growth (much of which is fake anyways due to counting financialized 'gains' as a legitimate part of production).


Chris, as you know I don't believe in the systemic requirement (flow perfection most definitely not required) for credit growth due to "not having enough money to pay the interest", and I have complete confidence if I were able to sit down with you and diagram it out you would be able to at least understand my point of view and you might even agree with me.  My modeling brain is totally wrapped around the problem - systems and models really are what I have done for decades - and interest payments just aren't a problem from a system design standpoint.
That said, I completely agree with everything else you've said about our predicament.

There are different factors at work in my economic model that have nothing to do with any systemic requirement of money supply required to pay interest, yet those factors lead to exactly the same problematic situation: we must keep the debt growing, or things go right off the cliff.

Because of the capital allocation that has happened in order to service our "excess consumption", any attempt to restrain debt growth leads us right over the cliff into a deflationary spiral, driven by an inability to service existing debt at a baseline level of national income.

Model says that once confidence tanks, debt repayment/savings starts to happen, production drops, more unemployment happens, debt service becomes more difficult, defaults occur, banks fail, deposits vanish, companies fail, more savings happen, and things continue to spiral down until only the companies providing basic goods and services remain.  I.e. the usual deflationary spiral.  Its not about lack of money supply because of a structural interest payment problem, its about a collapse in confidence which drives an increase of savings and a dramatic reduction in the velocity of money.

And if you recall, my contention is that velocity of money > 1 is what allows people to make their interest payments.  Drop velocity, and all else being equal, more defaults will happen.  And when confidence gets hit, velocity drops through the floor.

That's why the only way out - at least from Steve Keen's perspective - is a massive cash injection that liquidates the vast great mass of private debt in one fell swoop.  At that point, presumably we can go back to a baseline-only economy, side-stepping the massive deflationary spiral that will also get us there, but with a lot more pain and death.

One interesting side effect of Keen's jubilee is that we would suddenly move from a bank credit money system into a fiat currency system created by government, where the amount of currency in circulation that appeared from the helicopter drop (almost) completely replaces all the bank credit that in the past had been borrowed into existence.

But from the mainstream perspective - we gotta keep borrowing, or else all hell breaks loose.

Dave said,

Now project what happens if we start paying down our debt.  OMG.  Double down on that recession!  That's what Greece has been doing for the past six years.  And guess what happened to their economy?  -25% to GDP.
I can't find any data to substantiate the idea that Greece has been paying down any debt, public or private, in net over the last few years.  I understand that debt growth is stalled.. but I question the idea that Greece is actually net paying down debt right now, vs. just making interest payments.  Can you please show the data behind your contention above?  Thank you, Jim

I wonder if this is the old confusion on paying down debts in real terms (as opposed to just a % of GDP) vs reducing annual defecits?
Anyhow here’s some relevant data on Greece…

Well, its hard to tell from here if the decline in debt is due to actual defaults, write-offs, or paydowns, but the debt is definitely declining.  Note: this is Greek bank debt, not Greek sov debt.  In addition to this fall in debt, the non-performing loans of Greek banks is supposedly upwards of 60%.

And telling a country they have to run a primary surplus basically puts the whole "debt growth" thing into reverse.  An economy structured to provide consumer goodies at one GDP rate suddenly loses its "extra" consumption from credit growth, and then has to actually start repaying the debt, which also happens to be massive compared to its income.  Only one result possible: defaults, bank failures, massive deflation and then depression.

From such depressions, Fascism and Communism appears.  National bankruptcy and/or jubilee is really a better option.

Please share.

There would be no impact on inflation/deflation?  If most of the debt is paid off with newly printed money and jobs don't improve how does this help?  So banks have newly printed $'s and no main street customers so bid up assets even more in the casino.   In one sense the 2008 Bank Reserves Play are no different to Keen's suggestion.

As my son (an economics major) and I were driving down the main street of our small town the other day he said something I found pretty interesting.  "Ninety percent of these businesses could close and nobody would know any difference."  Now, this is a tourist town and there are Knicknacks, collectibles, ice cream, used books, 3 tattoo places, you get the idea, etc.  It looks like a successful downtown from the number of occupied storefronts, but what if anything even slightly negative happens to the economy?
My point is it requires people to continually buy, buy, buy, most likely with plastic, to continue this fantasy world we live in. And, if people stop buying useless crap this fantasy economy will falter.  Classic Catch 22.

The most dramatic direct impact of Keen's debt jubilee would be on the interest payment flow from debtors to creditors.  Keen's debt jubilee requires that all people with debt first apply their jubilee money to their debts.  For those that have bank debt, the jubilee money immediately liquidates that debt, freeing them from the interest payment, destroying the money in circulation.  At the same time, that reduces the cash flow to the creditor by the amount of the interest payment that is no longer being made.
In essence, jubilee money wipes out bank debt, right alongside the interest payment required to keep that credit money alive, freeing debt slaves from their debt.

For all the people who don't have any debt, this payment lands in their savings accounts.  Up to them what they do with it.

Assessing what happens next is the next exercise.  Definitely those freed from debt will likely increase spending - perhaps by as much as their P&I payments they are no longer making to their creditors.

Those without debt will also likely increase spending.

But most importantly, much less of a percentage of GDP would be going from the debt slaves to the debt masters once the debt jubilee was done.  It is definitely picking winners and losers.  If you're a debt slave, you really want a jubilee.  If you are a creditor, you do not want this to happen.  Who wants a pile of cash replacing the income stream from your debt slave? 

Is it inflationary?  Almost certainly.

Given the other alternatives, which involve either a) a continual increase in the overall debt as required to keep the debt monster fed (which deepens the debt slavery), or b) default and depression which historically leads directly to Communism or Fascist/Nationalism, I'd say the c) one-shot inflation from the jubilee is probably a better outcome than either of the other two.

Just my sense.

Given the debt masters control everything, its not going to to happen, but as an intellectual exercise, I think is worth considering.

If we were to have a Keen style jubilee creditors will suddenly be flush with cash that they would love to loan out again to restart their income flow.  Former debtors will naturally look at the situation and conclude there is no harm in borrowing again to upgrade their lifestyle.  They might expect to again be bailed out if the debt gets too big, if they even think that far ahead.  The end result, seems to me, is the debt cycle just begins again unless the jubilee comes with some kind of edict that borrowing will be strictly limited.  I don't see that happening in our current environment of massive corporate lobbying.

This time around the debt Jubilee payout will come at a cost. To be eligible for participation in the debt jubilee.
To help combat fraud, and to make sure those pesky terrorists don’t get their grubby hands on the green. Carrot and stick and all.
RFID microchip, anyone?

Makes sense that there were not as many credit worthy private borrowers in Greece after 2009… and that bank credit has net contracted, and that this has played a role in the GDP contraction.  I do believe that total debt has continued to increase though as a result of the borrowings of the Gov't on behalf of the people of Greece.   
Any idea what precipitated the nearly $80B vertical (upward) 2010 spike in credit shown on your chart?  Seems odd.  

On the subject of Jubilee… I do think it would help matters and help to extend the system… but I don't think it would work unless there was a simultaneous derivatives jubilee, and all of that unbacked debt and interest rate leverage was taken out of the system as well.      

JimH, Doug-

On the subject of Jubilee... I do think it would help matters and help to extend the system.. but I don't think it would work unless there was a simultaneous derivatives jubilee, and all of that unbacked debt and interest rate leverage was taken out of the system as well.    
Yeah we'd have to do a lot of reform alongside the Jubilee for it to "stick".  Placing all derivatives on exchanges and properly reserving for them would fix the derivatives problem.  And while I'm wishing for the moon, we might as well re-instate Glass-Stegall for real, and break up the TBTF banks.

That would get us back to relationship banking, where every bank keeps the loans they make on the books.  No more transactional banking.  And while we're at it, we can use Steve Keen's mortgage lending suggestion, where no property loan can be made unless inferred rental income from the home is below some fixed cap rate, perhaps 10%.  Perhaps we do this by slapping that limit on Fannie/Freddie provided insurance.  "No more government-insured ponzi property loans".

And also, I do agree, that people who were in trouble prior to the Jubilee will most likely end up getting in trouble once again given time.  As long as lending standards are maintained, they won't be able to get in as much trouble as they did before.

Fewer stupid loans get made if the banks must keep them around.  It doesn't eliminate stupidity, but it probably dampens the amplitude of the next crisis.

None of this fixes human idiocy or the business cycle, but it does cause a system reset that avoids the very worst of the depression effects.

Now, you might ask - related to Doug's point - are the nasty depression effects a required part of the business cycle?  Must we live through 7-20 years of lean in order to teach us collectively not to be such a bunch of idiots?

I think that's perhaps the most interesting question, and one that's more metaphysical than economic.  I can wade into that somewhat.  I think the answer is most likely yes, we need to periodically fall into the ditch in order to teach us to watch where we are going.  Perhaps the state of our self-imposed rules are merely a reflection of how aware we are currently of our own problematic nature regarding windfalls and ponzi schemes.

However, I think there is a fair amount of malicious mischief going on that is trying hard to keep us all asleep.  Lots of different viewpoints come to this same conclusion.  I think our time spent in the ditch doesn't need to be nearly as long as in Greece - although for sure, the longer we spend there, the more thoroughly we learn the lesson.  Too long, and we end up with a Hitler, and once that happens we need to run off and learn a bunch of even more disagreeable lessons.

Another question we might consider is, might that urge to buy into ponzi schemes be integral to enabling the build-out of new technologies?  Witness: railroad overbuilding, hundreds of car companies in the 1920s, silly internet companies during dotcom.  As Arthur said in another post, paraphrased, do genius and crazy come hand-in-hand?  If we eliminate the ponzi (, do we also eliminate the workhorse google too?

This is not how I understand  it to work…If someone obtains circulating money and uses that to pay off a loan, then both the debt and the money are extinguished.  That's true.

But not in a Jubilee.

Consider the two mechanisms that could work; (1) money is created, handed to debtors, which they use to pay down debt and (2) the debts are simply forgiven - wiped from the books, or reduced by some amount, say $50,000 per household.

In either (1) or (2) the original money that was created when the loan was made remains in the system.  It is not destroyed, in fact it now has no corresponding debt offsetting it, which means it has been instantly transformed into base money. So the ratio of base money in the system goes up by the amount of the Jubilee.

A quick example.  I borrow $100,000 against my house and use that money to redecorate.  I spend it on sofas, Persian rugs, painters, and a very nice fountain.  All of that money is "out there" in other people's bank accounts.  For simplicity's sake, assume they have no debts of their own (although it doesn't really matter in terms of how the story ends, we just get to skip chasing down another set of steps) and so this new money is in their bank accounts.

Now I get a one-per-family $100,000 Jubilee payment form the Fed and I use it, as instructed, to pay off my $100,000 HELOC.  Now my debt is paid off (canceled) and the $100k Fed money and my debt disappear in a process like a matter/anti-matter annihilation event.

But the $100k I spent is still out there.  It's out there no different than if the Fed just pumped another $100k of base money into the system, except that it's not being handed to banks first but to people and corporations.  This explains why a Jubilee would be inflationary…a lot more inflationary than QE unless people and corporations show the same sudden taste for high art and over-priced stocks that the banks and their prime speculating clients have shown.  Then we'll just get more of the same type of inflation we've already seen.

A Jubilee is actually a very aggressive monetary event, and I doubt it would result in the same sorts of inflation we've already seen, which is why I would recommend that people pre-buy the things that more ordinary souls would tend to buy if given a windfall because those are the things that will rather suddenly inflate.  Houses, cars, consumer goods, gold and silver (later in the story), and land seem more likely to spike in response to a Jubilee than equities and bonds.  But I'm prepared to be surprised…humans are quite unpredictable when it comes to fads.

At any rate, a Jubilee does not destroy money in circulation, it cements it by turning credit money into base money.



At any rate, a Jubilee does not destroy money in circulation, it cements it by turning credit money into base money.
Right you are.  I stand corrected.  The loan (bank's asset and your liability) as well as the new cash go poof, but the previous deposits remain.

So how does this affect things?

Well, there's suddenly a lot more money out there that doesn't have an interest payment attached to it.  I'd guess this would result in lower aggregate interest costs for society, lower income for bankers, but also an even lower interest rate paid to savers.

In addition, for each unit of old base money, the Fed has a corresponding asset.  With each unit of Jubilee Cash, the Fed has no asset backing that new unit of base money in circulation.  Therefore, the Fed can never remove that money from circulation by selling an asset, which is why you said it is cemented into circulation.

Our friendly Jubilee'd bank now has deposit liabilities in excess of assets.  It will dump the excess deposits - it has no need for them.  Where do the deposits go?  Possibly excess reserves?

Without asset sales by the Fed, the excess reserves problem probably gets worse.

The Fed could always sell some bonds, removing the old base money from circulation, but of course that makes long rates jump higher, which runs counter to what they want.

Seems like they could print up to 4 trillion in Jubilee Cash and hand it out, then sell their bond collection, and not much would change from the standpoint of money scarcity.  Fed would be stuck with some nasty losses on their debt, and they would no longer have interest income, which would add to the deficit.

If most of America has credit card or mortgage debt, it might not be all that directly inflationary.  Of course people could lever right back up again, but would they?  They didn't spend all that money from lower gas prices.

I'd imagine it would be gold-positive.

The Fed could always get back into balance by revaluing gold dramatically higher, to balance it off against the new base money cash they dropped into circulation…

The PTB will only let it happen when they see their own fortunes threatened, after a crash for example.

I'm not sure you are correct. The jubilee fund itself is base or vertical money from the Central bank.
The payment extinguishes the banks debit account with the customer. The asset, the loan document, is returned to the customer so it is extinguished. The bank has extinguished the account, by using base money to extinguish broad or horizontal money. Both came from "thin Air"

The customer's asset is wholly his/hers. It is property or whatever. It is outside the financial world, at least temporarily. 

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