I am not sure where I came across this article. If it was on EP, I apologize for not giving credit but it may have been Calculated Risk. This article has some sombering graphs.
The article titled "US Household Deleveraging and Future Consumption Growth", by Reuven Glick and Kevin Lansing, articulates (much better than I can) why future economic growth may be relatively weak or anemic. The article suggests that U.S. households may continue to "deleverage" which may result in less consumption. It concludes that this "deleveraging" will not be painless.
U.S. household leverage, as measured by the ratio
of debt to personal disposable income, increased modestly from 55% in 1960 to 65% by the mid-1980s. Then, over the next two decades, leverage proceeded to more than double, reaching an all-time high of 133% in 2007. That dramatic rise in
debt was accompanied by a steady decline in the personal saving rate. The combination of higher debt and lower saving enabled personal consumption expenditures to grow faster than disposable income, providing a significant boost to U.S. economic growth over the period.
Wow, 133% debt to personal disposable income ratio. The current household leverage ratio is 130%.
This article makes two historical comparison. First, to the Great Depression:
History provides examples of significant deleveraging episodes, both in the household and business sectors, which offer a basis for gauging how debt reduction
may affect spending. From 1929 to 1933, in the midst
of the Great Depression, nominal debt held by U.S.
households declined by one-third (see James and Sylla 2006). In a contemporary account, Persons(1930, pp. 118–119) wrote, “[I]t is highly probable that a considerable volume of sales recently made were based on credit ratings only justifiable on the theory that flush times were to continue indefinitely....When the process of expanding credit ceases and we return to a normal basis of spending each year,...there must ensue a painful period of readjustment.”
Second, and more interesting, to Japan's private nonfinancial sector in 1990s:
private nonfinancial firms in Japan
reduced their debt relative to GDP by roughly 30
percentage points over 10 years following the bursting of twin bubbles in stocks and real estate in the early
1990s. Firms slashed their debt by significantly reducing
the growth of investment spending.
If our current economic crisis is anything like the Great Depression or even Japan in the 1990s, economic growth will be painful.
The main problem is debt levels and in my opinion, the greed of financial conglomerates:
Beginning in 2000, however, the pace of [U.S. household] debt accumulation accelerated dramatically. Much of the run-up in debt was mortgage-related. During the
decade, a combination of factors including low interest
rates, weak lending standards, the spread of
exotic mortgages, and the growth of a global market
for securitized loans promoted increased borrowing.
Because of these unsustainable debt levels and the bursting of the housing bubble trillions of dollars of wealth tied to real estate and the stock market has been wiped out. Amazing how the financial sector created all this illusory wealth. Who benefited from this illusory wealth? A few lucky speculators and executives and other employees with financial conglomerates who received huge bonuses.
This article's main point is that if history is any indication, people will "deleverage" at an incredible rate:
Going forward, downward pressure on debt is likely
to come from both lenders and households.On the supply side, tighter lending standards will require more income, collateral, and documentation for any given loan. Demand for mortgage debt could also wane as expectations of future house price appreciation are adjusted downward to reflect market conditions. Concerns about future job security and the risk of
foreclosure or bankruptcy may spur consumers to boost their precautionary saving.Moreover, the need to rebuild nest eggs held for college education or retirement may prompt consumers to shift toward a more saving-oriented lifestyle.
While this "deleveraging" is needed, it may expose another structural weakness in our economy: over-reliance on consumer spending.
Figure 2 shows that real consumption and real debt
growth have been strongly correlated since 1960. Rapid debt growth allowed consumption to grow faster than income. Conversely, if households were to go through a sustained period of deleveraging (negative debt growth), then consumption growth would be expected to slow.
This is article is very interesting for comparing our current situation with Japan's private nonfinancial sector in 1990s. If the comparison is correct then we have a lot of "deleveraging" to do:
After Japan’s bubbles burst, private nonfinancial firms undertook a massive deleveraging, reducing their
collective debt-to-GDP ratio from 125% in 1991
to 95% in 2001. By reducing spending on investment,
the firms changed from being net borrowers to net
savers. If U.S. households were to undertake a similar
deleveraging, their collective debt-to-income ratio
would need to drop to around 100% by year-end
2018, returning to the level that prevailed in 2002.
The authors point to the recent increase in the personal saving rate that people may be "deleveraging".
A simple model of household debt dynamics can be
used to project the path of the saving rate that is
needed to push the debt-to-income ratio down to
100% over the next 10 years—a Japan-style deleveraging.
Assuming an effective nominal interest rate
on existing household debt of 7%, a future nominal
growth rate of disposable income of 5%, and that
80% of future saving is used for debt repayment, the
household saving rate would need to rise from around
4% currently to 10% by the end of 2018. A rise in
the saving rate of this magnitude would subtract about
three-fourths of a percentage point from annual
consumption growth each year, relative to a baseline
scenario in which the saving rate did not change.
An even larger subtraction from consumption growth
would occur relative to a baseline in which the saving
rate were declining, as occurred prior to 2005. In
either case, the subtraction from consumption growth
would act as a near-term drag on overall economic
activity, slowing the pace of recovery from recession.
Ouch! Here is the problem the growth in household incomes has been weak so this "deleveraging" will happen in either two ways: 1) people will continue to pay-off debts and spend less; or 2) defaults on existing debt will continue at high cost to us and financial conglomerates. Either case any economic recovery may be painful.