The NY Times Economix blog asked how much debt should households have. They identify a ratio total household debt to disposable income. It’s a very interesting chart which they do explain in easy to understand terms. A value of 100% means that for every dollar of disposable income someone has, they have 1 dollar in debt. The post concludes by accepting the fact that no one knows what the optimal value should be for a sustainably growing and healthy economy. It could be 120%, or something below 100%. For safety’s sake it should be below 100% (and of course all you personal finance junkies would actually want the number to be closer to 0. But debt can be a good tool for growth and without it our economy would be in even worse shape.
Their post got me thinking about something else, something more personal finance related. The question I’m asking is how much debt is too much. Specifically, how much revolving debt (such as credit cards and opposed to fixed payments like mortgages) can you actually have and continue to have enjoy a healthy lifestyle. The chart below may help us.
This chart focuses instead on the savings of individuals instead of their incomes. The blue line is total savings whereas the red line is total revolving credit balances. If you look at the crossover point in the mid 90s as the start of unsustainable levels of debt, we can clearly grow a bubble for more than a decade before problems occur. If there was ever a concern about a credit bubble though, it is clearly deflating.
But does this chart answer the question of how much debt is too much? Maybe. It’s clear that the level of debt we can have is also based on the state of the economy. If you look closely, the amount of credit we take out slows in each recession (shaded areas) but only in a serious recession (our current one) did the trend actually reverse. Did it reverse because the recession was a big one, or because we simply finally overextended ourselves?
It’s actually both. Previous recessions weren’t as bad for the consumer, partially because we borrowed our way through it. We can’t do that in this one, obviously.
The question then remains, how much debt is too much? As always my opinion is split. There is the amount that is good for the economy, and the amount that’s good for the household. In the household, you want to keep revolving credit at a minimum, and at least not exceed your savings over the long term. In other words, save enough money to cover your revolving debts, if you insist on running up the debts. This has the effect on this chart of keeping the blue line above the red. What’s good for the economy may be a greater use of debt.
But the truth is, it’s not the level of debt that really matters, it’s what you’re borrowing it for. Revolving credit is any kind of loan that doesn’t have fixed payments. Think credit cards and home equity lines of credit. If you use this credit to improve your home or make some kind of business move, it may be a smart decision. But if you use the credit to buy TVs, boats, cars, or something else, it’s clearly a bad decision. This chart doesn’t make such distinctions. Inside a chart with those distinctions we could find our answer.
Here’s another good chart that breaks down borrowing trends by type over time. The good news is we’re cutting back everywhere.
 By The Weakonomist |
The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics. Also keep in mind that nothing I say can be construed as financial advice. |
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