Borrowing and the Business Cycle

Since I’m in a data groove today, I thought I’d put up a picture showing why I worry about whether the current economic recovery is sustainable. You can read about some of the details of my concerns in this earlier post, but here’s a graph to go with it.

The point is simple: borrowing should typically fall during recessions, and rise during booms. The shaded areas in the graph represent recessions (approximately), and the two lines represent two important types of borrowing: borrowing by the US as a whole from foreign countries (that’s the current account deficit, the blue line), and the total debt service that consumers in the US have to pay as a percent of their disposable income. As you can see, in every recession in the past, the US as whole, and consumers in particular reduce their borrowing and debt burdens. And then during every economic expansion, both measures of borrowing rise. That’s how the business cycle normally works. But this time, that hasn’t happened.

If the US economy were to enter a period of strong growth now, we would expect both series to rise sharply, as they have during every previous recovery. But it seems impossible that consumer debt could boom at this point, and that the US current account deficit could grow much larger. Hence my feeling that somehow, these two measures have to fall first before they can rise again – and hence my fears that the other shoe has yet to drop on the US economy.