138 Years of Economic History Show that It’s Excessive PRIVATE Debt Which Causes Depressions

Too Much Government Debt Hurts the Economy … But Too Much Private Debt KILLS It

Preface:  We like to debunk myths held by both the left and the right.

For example, we have repeatedly argued that government debt and deficits do matter. Over a certain level, they form a large drag on the economy. That pisses off our liberal readers.

But we keep pointing out that – instead of imposing draconian austerity – it would be much better for the economy to stop handouts to the big banks, stop getting into imperial military adventures and stop incurring unnecessary interest costs (and see this). That infuriates our conservative readers.

This post, however, focuses on private rather than public debt.  Prepare to be offended … and lock up your sacred cows before we find and slaughter them.

The National Bureau of Economic Research has published a new paper analyzing 138 years of economic history in 14 advanced economies, which proves that high levels of private debt cause severe recessions.

As summarized by Business Insider:

Through a series of tests run on a sample of 14 advanced economies between 1870 and 2008, Mr Taylor establishes a link between the growth of private sector credit and the likelihood of financial crisis. The link between crisis and credit [i.e. private debt] is stronger than between crises and growth in the broad money supply, the current account deficit, or an increase in public debt.

Over the 138-year timeframe Mr Taylor finds crisis preceded by the development of excess credit, as in Ireland and Spain today, are more common than crisis underpinned by excessive government borrowing, like in Greece. Fiscal strains in themselves do not tend to result in financial crisis.

The study shows that excessive private debt is a much more accurate and consistent predictor of financial crisis than the amount of public debt. (However, high levels of public debt exacerbate the problems caused by massive private debt, since governments which are already “in the red” have little ammunition left with which to help out the economy.)

The NBER study validates what Steve Keen has been saying for years: excess private sector debt is the main driver of deep recessions and depressions. And yet Ben Bernanke and all other mainstream economists literally believe that the amount of private debt doesn’t matter and isn’t even important to quantify.

(Even though economists at the “central banks’ central bank” – the Bank of International Settlements – say that high levels of private debt creates a drag on the economy).

As Michael Clark notes, high levels of public debt are detrimental … but it is high levels of private debt which initiate depressions:

American Private Debt [was] 310% of Gross Domestic Product in 2008, the highest since 1929, the last Great Depression, when Private Debt was 240% of GDP.


Government debt in 1929 was a paltry 40% of GDP. In 1945, when America was financing its participation in World War II, government debt exploded to 120% of GDP. That is the highest government debt has been in America, making the 85% of GDP in 2011 seem almost insignificant.


Government debt vis-a-vis Gross Domestic Product is not astronomical, according to this chart. It was not high in 1929 either, the last time the global economy had a heart attack and died. Public Debt is, in fact, at the time of this chart at least, lower than in 1945, when the public financed American involvement in World War II.


There WAS a Real Estate/Housing Bubble and subsequent banking crisis in the 1920’s. In fact, the asset bubble that began in 1921 helped to cause the massive PRIVATE DEBT BUBBLE that destroyed the global economy then also. The web site below examines the housing bubble of 1921-1926.


The famous stock market bubble of 1925-1929 has been closely analyzed. Less well known, and far less well documented, is the nationwide real estate bubble that began around 1921 and deflated around 1926. In the midst of our current subprime mortgage collapse, economists and historians interested in the role of real estate markets in past financial crises are reexamining the relationship of the first asset-price bubble of the 1920s with the later stock market bubble and the Great Depression that followed….

What this all suggests is that American Big Business (Wall Street and Wall Street’s political lackeys in Washington) is refusing to take the blame for the Global Collapse it helped to create through the same mechanism it used in the 1920s, Private Greed, pursuing recklessly their own economic empires — asset price inflation fueled by lower and lower interest rates – and has attempted to shift the blame on to the governments of the world ….

The debt that must be destroyed before the global economy can reach a state of organic growth again is, primarily, Private Debt — private enterprise debt and private consumer debt….

Of course, Big Business has now found a convenient method for unloading toxic debt: by selling it at face value or even at future inflated value to the governments of the world. The governments are willing to buy worthless private debt in the hope of keeping themselves in power, of keeping their societies from unraveling into civil war and revolution. Why would Big Business ever concern itself with risk if there will always be a buyer of last resort willing to absorb the crimes and failures of the Free Market in pursuing the demon of Unlimited Wealth?

Then, of course, this forced ingestion of toxic (criminal?) debt by the governments in question — in hopes of avoiding civil war — has been followed by the political gambit of Big Business and the political supporters of Big Business screaming and shaking of fists at the government for taking on too much debt. Well, the ‘too much debt’ the public was taking on was the Disaster Debt of unregulated Big Business which made careless business decisions without considering risk or even to crimes in many cases (organized crime almost certainly, organized crimes in white shirts on Wall Street).

Clark notes that the same is true in Europe:


According to Paul De Grauwe, writing in the web-page below, only Greece, Italy and Belgium have government debt over 100% of GDP.


In fact, Spain and Ireland had very little government debt when the global economy sank in 2008. But they had huge levels of Private Debt, all connected to the Housing Bubbles out of which they were just emerging. Spanish government debt was less than 40% of GDP until the Titanic struck the ice. Ireland’s Public Debt was a fraction over 20%.

France (socialist France) had Public Debt that was only 45% of GDP.


Those who say that it is government profligacy that is the source of the debt crisis are mistaken. They also fail to see the inevitable connection between private and public debt. This connection is particularly strong in countries like Spain and Ireland that have been hit badly by the debt crisis.


Spain and Ireland were spectacularly successful in reducing their government debt to GDP ratios prior to the financial crisis, i.e. Spain from 60% to 40% and Ireland from 43% to 23%. These were the two countries, which followed the rules of the Stability and Growth Pact better than any other country – certainly better than Germany that allowed its government debt ratio to increase before 2007. Yet the two countries, which followed the fire code regulations most scrupulously, were hit by the fire, because they failed to contain domestic private debt.

So, what happened to us? Why did we crash? We crashed because businesses and individual consumers (Wall Street and Main Street) over-leveraged in an attempt to reap dream-like profits on the Housing Bubble, both as credits and as debtors. This feeding frenzy — encouraged by the Fed and the banks — it is an illusion that the Fed Chairman is not the pet figurehead of the banking establishment — destroyed our economy and is sending us into decades of pain.


Now — as Japan did — we are attempting to pare down Private Debt by handouts and bailouts and by the government buying toxic assets of the guilty parties — that is, to turn Private Debt into Public Debt [background], while we try to preserve the status quo, keep Old Money in Power, and avoid civil war — i.e., spending billions to try to keep asset prices elevated [background], and voters/citizens soporific.

There is a moral element that we should not miss: giving public money to the fools and crooks that destroyed the economy through greed and self-interest so they can try to do it again — the idea that Ben Bernanke would squat on interest rates so that he could feed money to reckless billionaires at the expense of retirees and savers is appalling.

(Indeed … see this, this and this.)

Financial Sector Debt Is a Bigger Problem than Consumer Debt

As Anthony Randazza notes, Americans started to reduce their debt and deleverage at the start of the financial crisis … but have slid backwards again in the last couple of years:

America had started the process of household balance sheet deleveraging after the bubble burst. Mortgage debt levels have fallen sharply. And consumer credit—all debt other than mortgage debt—was declining as well. But in the summer of 2010, as the post-recession faux-recovery created false hope that the good times were back and as savings decimated by the bursting bubble began to hit zero in the midst of a weak economy, consumer credit levels (led by credit card purchases) began to rise again.

The figure below shows that consumer credit fell 7.1 percent from June 2008 to June 2010, but since then has grown 6.9 percent to June 2012 (according to data released this month by the Fed).

Total Consumer Credit

This is indeed troubling.

But as we’ve previously documented, it is financial company debt – i.e. leverage – which is the main problem (and see this and this).

As Keen notes:

Figure 5: Separating out private sector and public sector debt in the USA

This is more apparent when we look just at the change in debt: private and public debt move in opposite directions.

Figure 6: Private and public debt move in opposite directions

Finance sector debt matters

Ignoring finance sector debt is a mistake. Firstly, it’s huge: by far the largest component of debt, private or public, in the USA (see Figure 7).

Figure 7

Secondly, finance sector debt is not a “zero sum game”. Though lending by a non-bank financial company to another entity doesn’t create money, it does create debt; and the initial lending by a bank to a non-bank creates both credit money and debt. Since the finance sector was the source of most of the speculative debt that fuelled the bubble, and it is by far the major force in deleveraging now, leaving it out of the analysis exempts a major causal factor in both the pre-2008 boom and the post-2008 debacle.

Angry Bear writes:

[Consumers certainly rang up too much debt.] But that ignores the really massive runup: financial corporations’ debts. Starting at a little over 10% of GDP in 1970, they hit almost 80% by 2000, and when the crash hit they were over 120% of GDP — a 10x, order-of-magnitude increase over 40 years.


The basic story is very simple. It goes like this (in my words):

• Banks (and shadow banks) make money by lending. Bankers have every incentive to increase their loan books, even by extending questionable loans, because bankers don’t personally bear the eventual, down-the-road losses from loan defaults — they’ve gotten their money already.

• When banks run out of real, productive enterprises to lend to — enterprises that can pay back loans and interest from the production and sale of real goods that humans can consume — they start lending to speculators (gamblers) who are buying financial assets in hopes that their prices will rise.

• That lending — extra money being pumped into the system — does indeed drive up the price of financial assets, far beyond the value of the real assets that (according to most economists you listen to) supposedly underpin those financial assets’ value.

• Eventually people realize that the value of financial assets far exceeds the value of real assets — and far exceeds the capacity of the real economy to service the loans that drove up those financial asset prices. Prices of financial assets plummet, borrowers default because there just ain’t enough real income to service the loans, financial-asset prices plummet some more, all in a downward spiral — with all sorts of collateral damage to the real economy.

There’s your (economy-wide) Ponzi scheme. Households and nonfinancial businesses definitely participate (the financial industry makes it almost irresistible not to), but it’s driven by the financial industry, and a huge proportion of the takings go to players in the financial industry.

And Michael Clark notes:


While the government debt ratio in the Eurozone declined from 72% in 1999 to 67% in 2007) the household debt increased from 52% to 70% of GDP during the same period. Financial institutions increased their debt from less than 200% of GDP to more than 250%.

What’s the Solution?

We are in a bit of a pickle.

As Keen warns:

[We’re going into] a never-ending depression unless we repudiate the debt, which never should have been extended in the first place.

What’s the solution?

To remember history.

Specifically, we’ve known for over 4,000 years that debts need to be periodically written down, or the entire economy will collapse.

The ancient Sumerians and Babylonians, the early Jews and Christians, the Founding Fathers of the United States and others throughout history knew that private debts had to be periodically forgiven.

Debt jubilees are a vital part of the Christian and Jewish faiths. And the first recorded word for “freedom” anywhere in the world meant “debt-freedom”.

As some of the leading modern economists argue, forcing big banks, bondholders and other creditors to write down some of their bad debts is the only way out of our economic malaise.

Even the Bank of International Settlements says that debts have to be written down to a level where they can be paid.

And the IMF points to Iceland as a model for debt writes offs as a way out of its economic slump.

Note:  If you want to know learn about Minsky’s economics, read Steve Keen, not faux Minskyians.

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  • The western world’s economic system is based on greed. A recent survey conducted by law firm, Labaton Sucharow, among Wall Street executives showed that 24% of them believed it kosher for the financial employees to engage in unethical or illegal conduct in order to be successful. In December 2010, Newsweek, had boasted that Jewish Talmud is a Business Guide in China.

    The pro-Israel Zionist groups have been running a vicious smear campaign against the Occupy Wall Street (OWS) movement since day one. The movement has been labeled as ‘anti-Israel’, ‘anti-Jewish‘, ‘pro-terrorism’, ‘pro-Hamas’, ‘anti-Zionism’ and having links to Egyptian Muslim Brotherhood and Islamic regime in Tehran.


  • Great info, with a couple of caveats:

    — actually, if you want to learn about Minsky, a good place to start would be with his grad student, now college professor, Randy Wray. Or Wray’s colleague at UMKC, Stephanie Kelton. Keen is cool, too, but not as willing to share his knowledge as the UMKC bunch.

    — you repeat the myth that government debt is a problem, citing Greece. Government debt is not a problem for monetarily sovereign countries that issue debt in their own currency, like the US or Britian. Greece is not monetarily sovereign, and owes debt in Euros, not in Greek drachmas. It makes a difference.

  • gozounlimited

    Exactly what these ladies are talking about ….. “We are the new and unsettling force that Martin Luther King spoke for” …. Dr. Jill Stein Accepts 2012 Green Party Presidential Nomination, 4/6

    see here: http://www.youtube.com/watch?v=f1sveBceqFY&feature=relmfu

    read here: http://grist.org/election-2012/green-partys-presidential-candidate-says-its-time-to-take-our-country-back/

    Cheri Honkala Acceptance speech for Vice President at Green Party Convention

    Cheri Honkala, former Green Party candidate for Sheriff of Philadelphia PA, talks about her experience from being homeless to becoming an anti poverty activist and into the electoral arena as a Green. Honkala is running with Presidential candidate Jill Stein.

    see here: http://www.youtube.com/watch?v=n0dbChz_tVk

    Jill Stein’s message of change, on which real hope depends ….. see here: http://www.youtube.com/watch?v=0-tDYKOrcY8&feature=related


  • I agree generally. I would just point out that it is a red herring to point to 94% public-debt-to-GDP as some sort of magical number. The Reinhart and Rogoff study found a statistical correlation between government debt ratios higher than roughly 90% and slower growth, but as we all know, correlation is not causation. I haven’t looked at the study in enough depth to make any categorical statements, but couldn’t it be that high government debt ratios are often a by-product of private debt deflations, such that the statistical correlation between high government debt ratios and slow growth that Reinhart and Rogoff identified is fundamentally attributable to prior excessive *private debt* ratios?

    Just saying…

  • cupcake

    >But we keep pointing out that – instead of imposing draconian austerity – it would be much better for the economy to stop handouts to the big banks, stop getting into imperial military adventures and stop incurring unnecessary interest costs (and see this). That infuriates our NEOconservative readers.


    Conservatives say the exact same thing you are saying. It’s the neoconservatives who voted for the bailouts, support the Federal Reserve, and support our interventionist foreign policy.

    Also, the growing private debt is a response to artificially low interest rates (pushed forth by the government) and inflation (created by the Federal Reserve). Ignoring the role of the Federal Reserve in the crisis is like talking about how grass grows without mentioning water.

  • in this line, you’ve transposed “public” and “private” and intend for it to read “private” but it says “public” (link says “private”)

    As Michael Clark notes, high levels of public debt are detrimental … but it is high levels of public debt which initiate depressions:

  • mr. mike

    If you want to be horrified, check out the New York Times’ recent series on student loan debt; one in six student debtors have defaulted. To add flaming gasoline to a sewage stew, half of the commenters wagged their fingers and claimed that students were using the money to live well….which is myopic insanity as the lending agencies send the money to the schools directly and the student never sees it. The article mentioned collection agencies that harass debtors on a daily or weekly basis with calls, but they forgot to add that collectors will often dial anybody with the same last name as their target, spreading the misery…..and that “zombie debt” also applies to student loans; people have paid off their loans, only to have the DOE call a decade or so later demanding back payment. People have literally fled the country to get away from SL debts because they have no right of bankruptcy under the “new” student lending laws of the 1990s which were created to fight a problem that didn’t exist.

    I agree with the article on this blog; there needs to be private debt relief.

  • James Crow

    Utter nonsense. Removing your book mark. I’m not offended by your post, but by your utter lack of insight, knowledge and understanding. If you had one iota of intelligence you’d have already realized the whole enchilada has been manipulated for a couple of centuries, well before the illegal federal reserve act was illegitimately passed. Your blog has suffered for months since you reformatted, and is now but a pale grey joke of the legitimate concerns you used to post. Very subtle but very obvious.

  • Steve

    It doesn’t piss me off as a liberal that federal debt may be a drag on the economy. What pisses me off is that the party that is pushing this the hardest is the same one that created most of it. Apparently, the Bush years never happened. Even now, Republicans are not opposed to debt, as long as it is not spent on the poor. They are not, and never were, “small government”. Also, there seems to be a lack of attention to the numbers – the federal deficit is currently falling, not rising.

  • Dexter60

    Just as certainly one can blame the electorate if they ‘vote’ themselves into a dictatorship — but the basic problem is they have tossed out a government by the consent of the governed by refusing to support the law of the land in the first place and allowed criminals to make their decision for them.
    The economic issues are merely an easy way of keeping score, not the way to find real answers and the secure survival of civlization in our time.
    The rest is bull roar.

  • Scott

    Steve identified an new axiom for me: “Republicans are not opposed to debt, as long as it is not spent on the poor. “

  • The Arthurian

    “excess private sector debt is the main driver of deep recessions and depressions.”


    • BobFromDistrict9

      I was just going to ask for the link. Thank you.

    • BobFromDistrict9

      Whoops, the page has been deleted.

  • Take a look at the debt-reset theory of macroeconomics on Wikipedia, and please adjust accordingly. Some of the graphs here on this site are very good.

  • Gerry Hiles

    Excellent, plain language descriptions and explanations. Thanks WB from Setarcos in ZH, from whence I came to read this. You write a lot of good stuff and about my only reservation is your reluctance to completely ditch the Washington/White House conspiracy theory that OBL and 19 non-pilots “dunit” on 911.

  • BobFromDistrict9

    “For example, we have repeatedly argued that government debt and deficits do matter. Over a certain level, they form a large drag on the economy. That pisses off our liberal readers.”

    That was a stupid thing to say.

    The idea that all members of one persuasion agree on some detail of a general issue is truly stupid.

    Damn few people on either side would deny debt and deficits do matter. OK, Dick Cheney did deny it, so make that damn few rational people.

    What the author overlooks is that you very seldom or never have an absolute opportunity to chose one way or the other, it always involves tradeoffs.

    Yes, levels of national debt are often low before a recession. Before the Great Depression US national debt was at 16% of GDP.

    However, his solutions are frighteningly valid.

    What he forgot to mention in his history lesson is, bankruptcy is on the US Constitution. The founding fathers thought it was that important.

    A massive failure was exempting student loans and medical bills from bankruptcy, and making it more difficult in general in the 2005 bankruptcy so called reform act. Repeal it.

    I’m afraid his chopping block thinking will prove to be the only real solution… other than massive inflation to inflate the debt away. I guess, it’s really the same thing.

  • BobFromDistrict9

    Oh, and I ordered the NBER report you linked. Thanks for the link.