Macro Wrap – Increased Inequality and Rising Debt Loads Are Tied at the Hip

by Enis September 12, 2013 7:55 am • Commentary

This chart yesterday caught my attention.  By way of Barry Ritholtz’s blog (who got it from the NYT):

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The economic implications of increased inequality are much less frequently discussed than the political or societal implications.  But the economic impact of current inequality on future growth could be just as important.

Two of the overarching long-term issues facing the U.S. are inequality and the debt burden.  I view the two issues as closely linked.  The increasing debt burden (whether through mortgage, student loan, or now government debt) has been the preferred method of maintaining or increasing U.S. consumption over the past decade.  As I discussed in my Macro Wrap in May, a higher debt load does not come without costs:

Debt on its own does not change the wealth of the globe, as one person’s liability is another person’s asset.  But typically, the debtor has a higher propensity to consume (and arguably, invest in new projects) than the creditor.  As a result, an increasing debt load results in a lower propensity to invest and consume across the global economy.

The global debt load rose from around $80 trillion in the year 2000 to around $200 trillion in 2010, an annual growth rate of around 12% per annum.  Compare that to the 4.5% growth rate of global GDP in that same period.  Credit creation was an important driver of that growth, so the pullback in credit creation in the developed world in the past few years has hurt global growth, with monetary policymakers attempting to offset that de-leveraging.

This discussion highlights why deflation is a bigger risk than inflation, though.  $2-$3 trillion of monetary easing is not that powerful a force in the face of hundreds of trillions of dollars of outstanding debt.  Economic growth is an imperative, but ideally it would be achieved without increasing the debt load further.  Unfortunately, that seems a herculean task at best given current trends.

Increased inequality and rising debt loads are tied at the hip.  Economic overcapacity suppresses median income growth (and in the case of the U.S. in the past 10 years, median incomes are actually 10% lower).  This economic weakness is dealt with increased stimulus, both monetary and fiscal, which generally benefits owners of capital more than owners of labor.  Moreover, the poorer segments of society are already dealing with the pernicious effects of increased debt loads (since their balance sheets are weaker due to their higher propensity to consume in the previous cycle).

The increased inequality puts more potential consumption power in the hands of the wealthier relative to those less wealthy.  But again, they have a lower propensity to consume, so overall consumption growth is weaker.

As a result, I’m not surprised when I see that the prior episode of significant inequality in the U.S. (the roaring 20’s) was followed by a long period of stagnation.  As Henry Ford noted, if the workers at his factory couldn’t afford his cars, then his opportunities for long-term expansion were much more limited.