Credit Economy Chart
It's important not to take economic models seriously. Just for grins I created a model based on how the economy has been growing the past 5 years. I pushed this same 'model' into the future. I assume that the economy will start to break down when the debt service ratio approaches 30% (Japanese economy, Canadian government, etc.). Currently the FOR by the Fed is about 20%. So how far can we go?
In blue, the debt to gdp ratio (right axis) climbs and climbs as we've seen in the past 5 years. The other color shows the financial obligations ratio which is now about 20% otherwise known as the debt service ratio (left axis). It's the amount of income devoted to debt service. It also climbs as the debt climbs but the Fed fights this by lowering the average interest rate. After every recession, the FOR drops for a few years before it rises again as the debt builds up. The end interest rate is 3% which is probably the lower bound as banks have to have some spread- it's currently 6%.
Based on the Fed saving us after each recession/bubble burst, the debt level can build to truly large proportions, 1000% debt to gdp, before monetary policy becomes ineffective and economy falls to deflation. Of course, this assumes the congress doesn't start a trade war and China's cheap labor pool is available. This way the finance economy can grow to huge dimensions. Otherwise, credit ends up in CPI and the Fed has to raise or maintain interest rates instead of lowering them.
Of course, this is a simple model. I don't want to take it too seriously, but it does show that the credit game can go on a long time. The table for the chart above appears here. The economy grows at 6% annualized (as it has the last 5y - I use actual dollars not 'adjusted inflation' dollars). Credit grows at the rate indicated. If you look at the fed's Z.1, you will see that the credit growth rate falls before a recession by about 2% and then increases after that at 1% per year. I assume a recession every 5 years.
| How to Manage a Bubble Economy… | 2.50% | Asset Price Index | ||||||||
| GDP | FOR | Interest | Av. Int. Rate | Credit | Credit Gwth | Credit/GDP | CPI | Real GDP | API | |
| 1 | 13.2 | 20.0% | 2.6 | 6.0% | 44.4 | 10% | 3.36 | 1.000 | 13.2 | 1.00 |
| 2 | 14.0 | 20.4% | 2.9 | 6.0% | 47.9 | 8% | 3.42 | 1.025 | 13.7 | 1.04 |
| 3 | 14.8 | 21.0% | 3.1 | 6.0% | 52.2 | 9% | 3.52 | 1.051 | 14.1 | 1.10 |
| 4 | 15.7 | 21.7% | 3.4 | 6.0% | 57.4 | 10% | 3.65 | 1.077 | 14.6 | 1.17 |
| 5 | 16.7 | 22.8% | 3.8 | 6.0% | 63.7 | 11% | 3.83 | 1.104 | 15.1 | 1.26 |
| 6 | 17.7 | 20.2% | 3.6 | 5.0% | 71.4 | 12% | 4.04 | 1.131 | 15.6 | 1.36 |
| 7 | 18.7 | 21.0% | 3.9 | 5.0% | 78.5 | 10% | 4.19 | 1.160 | 16.1 | 1.45 |
| 8 | 19.8 | 22.0% | 4.4 | 5.0% | 87.2 | 11% | 4.39 | 1.189 | 16.7 | 1.55 |
| 9 | 21.0 | 23.2% | 4.9 | 5.0% | 97.6 | 12% | 4.64 | 1.218 | 17.3 | 1.68 |
| 10 | 22.3 | 24.7% | 5.5 | 5.0% | 110.3 | 13% | 4.95 | 1.249 | 17.9 | 1.84 |
| 11 | 23.6 | 21.3% | 5.0 | 4.0% | 125.8 | 14% | 5.32 | 1.280 | 18.5 | 2.03 |
| 12 | 25.1 | 22.5% | 5.6 | 4.0% | 140.9 | 12% | 5.62 | 1.312 | 19.1 | 2.20 |
| 13 | 26.6 | 24.0% | 6.4 | 4.0% | 159.2 | 13% | 5.99 | 1.345 | 19.7 | 2.40 |
| 14 | 28.2 | 25.8% | 7.3 | 4.0% | 181.5 | 14% | 6.45 | 1.379 | 20.4 | 2.64 |
| 15 | 29.8 | 28.0% | 8.3 | 4.0% | 208.7 | 15% | 6.99 | 1.413 | 21.1 | 2.94 |
| 16 | 31.6 | 30.6% | 9.7 | 4.0% | 242.1 | 16% | 7.65 | 1.448 | 21.8 | 3.30 |
| 17 | 33.5 | 28.8% | 9.7 | 3.5% | 276.0 | 14% | 8.23 | 1.485 | 22.6 | 3.64 |
| 18 | 35.5 | 26.8% | 9.5 | 3.0% | 317.4 | 15% | 8.93 | 1.522 | 23.4 | 4.04 |
| 19 | 37.7 | 29.3% | 11.0 | 3.0% | 368.2 | 16% | 9.77 | 1.560 | 24.2 | 4.54 |
The asset price index shows if credit continues to flow to assets they could be 454% higher than they are today.
Of course, this model assumes no Black Swan meltdowns along the way which we are sure to get.
The US is only the middle of the pack for Debt to GDP. See these charts below-
As of 2005...US now beats Japan in household debt but not in gov't debt.
