The U.S. Economy Was Laden With Debt Before Covid. That's Bad News for a Recovery.
October 01 2020 - 12:12PM
Dow Jones News
By Shane Shifflett
The coronavirus brought an end to the longest economic expansion
in U.S. history. That wasn't the only problem. When the U.S.
barreled into the deep downturn that followed, it was laden with
debt.
Why does this matter? Economies carrying a lot of debt generally
have weaker recoveries. Businesses and consumers focus on cutting
their liabilities during downturns rather than spending cash -- and
spending is what an economy needs to rebound.
All told, the borrowing spurred by years of low interest rates
adds up to $64 trillion in consumer, business and government debt.
How much is that? It's more than triple the country's gross
domestic product. The series of charts below illustrate how we got
here and what it means for any recovery.
Some kinds of debt matter more than others. The most important
piece of a recovery is consumer spending, which accounts for nearly
70% of the U.S. economy. High household debt levels tend to
lengthen recessions and amplify their severity, according to a
study of advanced economies over 30 years by researchers at the
International Monetary Fund.
Economic growth over the past decade -- including big gains in
the stock market and in U.S. home prices -- has benefited wealthier
households the most, while those with lower incomes fell behind.
Real median household income fell after the financial crisis and
didn't surpass the inflation-adjusted 1999 record of $61,526 until
2016.
Mortgage debt, mostly held by better-paid workers, hasn't
changed much. Lower-income households, by contrast, have increased
their borrowing with auto loans, student debt and credit cards.
Before the pandemic, the percentage of delinquent auto-loan
balances had nearly reached levels last seen in the financial
crisis. Middle- and low-income consumers tend to spend more of
their earnings, so high debt levels mean they will likely consume
less.
Businesses have also borrowed at a record pace in recent years,
leading some economists to raise alarms last year that high levels
of corporate debt during a recession could force companies to slow
spending and hiring to repay what they owe -- or get simply
overwhelmed by their repayments.
Rather than use cash to invest in their businesses, many
companies bought back stock to boost share prices. Buybacks hit a
record $806 billion in 2018, following the tax overhaul that
lowered rates for many companies.
The quality of corporate debt suffered, with the amount of
corporate triple-B rated bonds -- the lowest quality
investment-grade debt -- more than doubling in the past decade.
Companies with such ratings risk downgrades, defaults and higher
borrowing costs when times get tough. So far, government stimulus
and low interest rates have helped companies avoid financial
struggles.
Meanwhile, state and local governments haven't been setting
aside enough to fund the increasingly expensive costs of pensions.
That will compound their problems now that sales and income taxes
have plummeted. Many state and local governments have already cut
services and furloughed workers.
Previous recessions have set back governments' ability to fund
pensions. Some states with heavy liabilities have taken loans tied
to specific streams of revenue, like sales tax, to keep borrowing
costs down, which will now be even harder to pay off.
Then there's federal debt.
Lawmakers in both political parties haven't been too concerned
with the growing federal deficit in recent years. It has ticked up
every year since President Trump took office, driven by increased
spending on defense, Congressionally approved programs and rising
Medicare and Social Security costs. Adding to the deficit this
year: $2.2 trillion in government stimulus.
The good news is that some economists and policy makers believe
federal debt is less of a concern than during past recessions,
thanks to low interest rates. Still, larger deficits mean greater
interest payments, which have quadrupled over the past two decades,
according to the Congressional Budget Office. Even after the
pandemic-related spending ends, the deficit is set to keep growing
to cover the rising cost of entitlements such as Social Security
and major health programs.
Graphics by John Gould--Illustration by Jessica Kuronen
Write to Shane Shifflett at Shane.Shifflett@wsj.com
(END) Dow Jones Newswires
October 01, 2020 11:57 ET (15:57 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.