Another day older

by Russ Roberts on May 12, 2006

in Standard of Living

A new study from the Center for American Progress purports to show that Americans are deeper in debt than ever before because income isn’t keeping up with expenses. I suppose this is probably true, but the implication is that the expense side is somehow exogenous–important stuff like houses and college tuition is getting expensive and incomes aren’t keeping up with costs.

As this CBS Marketwatch story says, quoting the author of the study:

"The middle-class squeeze [is driven by] stagnant income growth in the
face of very sharp price increases for big-ticket items such as homes
and education," said Christian Weller, author of the report and a
senior economist with the Center for American Progress.

I’m quoted in the article trying to make the case that people always want more than they can afford and that increased debt from increases home ownership isn’t a sign of economic crisis but a sign of economic health. You can’t just pick some expenses that are rising and use those to explain a rise in indebtedness.

The story also quotes Elizabeth Warren of Harvard who didn’t read the Sowell scarcity post:

Still, "there are forces bearing down on
middle-class families that require them to make choices that many of us
would find unacceptable, and we need to have some vision of that when
we make public policy choices," she said, noting that some people
decide to not purchase health insurance because they can’t afford it.

"What it took to survive in the middle class in the 1970s is simply not adequate today."

No, it isn’t. And what it took to survive in the middle class in 1870s isn’t adequate today, either. It’s not because the American economy is punishing the middle class. The reason is that we’re much richer. Our expectations of what is middle class has changed. If we would be content to live the life of a middle class person in 1870 we’d have no debt and could give an enormous amount to charity. But human beings don’t seem to behave that way. As they get richer, they want to consumer more. (And they give more to charity, too, at least more than they did when they were poorer.)

So why are Americans going deeper into debt? Todd Zywicki shows that debt has actually grown very little. What has changed is the composition of debt which allows scare-mongers to cherry-pick the kinds that have increased while ignoring the kinds that have decreased.  Bankruptcies are up, Zywicki shows, not because of increased indebtedness but because of reductions in the cost of declaring bankruptcy.

As for the general problem of debt, it is always wise to remember Mr. Micawber’s advice to young David Copperfield:

"Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought six, result misery."

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Bill Conerly May 12, 2006 at 7:11 pm

Home I grew up in: 1000 sq feet. Home I live in now: 2700 sq feet.
Vacations where we pay money to stay in a hotel/motel/rental house: 2 weeks in my 18 years of childhood. Vacation weeks in my last 18 years: 30 to 40, I'm guessing, including 3 trips to Europe, a couple to Mexico, many ski vacations, the point being they cost more than what my family did when I was a kid.
Dinners out when I was growing up: about once a month; now: about once a week, not counting take-out.
And my wife and I still watch the money and don't have enough for everything we want.

Henri Hein May 12, 2006 at 8:26 pm

Liz Pulliam over at MSN Money has been reporting on the true nature of consumer debt. For instance:

The truth about credit card debt

Aaron Krowne May 12, 2006 at 9:30 pm

Credit card debt is basically a red herring.

Mortgage debt is much more worrisome, especially since that's where a lot of the credit card debt went.

And national aggregates do have significant meaning for the general state of the economy. Debt is not wealth. Right? Can't we agree on that?

I guess not. Because this blog also seems to believe public debt is wealth.

What an innovation in accounting—the balance sheet has only one column, and it is labeled "assets"!

MjrMjr May 12, 2006 at 11:31 pm

"increased debt from increases home ownership isn't a sign of economic crisis but a sign of economic health."

Is this statement about the overal homeownership rate? I think I've seen stats that say that the homeownership rate has increased by around 5% in roughly the last ten years. I'd argue that a lot of people who were able to buy their first house in the last 5 years are marginal buyers who would not have qualified for a mortgage in years past. Lending standards have been extremely lax, and additionally a lot of these first time buyers stretched their monthly budget to the max and still had to get an ARM to buy their house. As these rates start to adjust upwards many buyers will find themselves unable to afford their monthly payment.

I don't think it's a coincidence that for sale housing inventory in Northern Viriginia is about 400-500% higher than this time last year. I think this housing market and many others in the nation are about to experience fairly significant price depreciation. Increased debt levels that are tied to the purchase of overpriced assets that are very likely to lose value isn't a reflection of wealth, it's a bubble.

Ben Litchman May 13, 2006 at 12:31 am

Totally unrelated: nice job on 20/20 tonight!

Zephyr May 13, 2006 at 9:09 am

Income is not the problem. People are spending too much of what they earn.

We have come to think that we must have many things that in decades past were clearly luxury goods.

Zephyr May 13, 2006 at 9:28 am

We are so much wealthier today compared to the 1970s and the 1960s. And it is not just the upper income people.

An anecdote in point: I recently flew to Florida on business and stopped for a shoe shine while waiting for my flight at JFK. The shoe shine guy asked where I was going and after I told him he mentioned that he had just flown back from there the week before. He said he goes there frequently.

In the 1960s flying anywhere for vacation was an extravagance for the middle class, and certainly out of reach for a shoe shine guy.

Ryan Fuller May 13, 2006 at 3:11 pm

An increase in debt under a fractional reserve system means more money is chasing after the same goods, which drives up prices. As a general rule, consumer debt directly impoverishes those who carry it and decreases the purchasing power of everyone else's money at the same time. That's a recipe for an increase in bankruptcies, made even worse by easy bankruptcy laws.

LowcountryJoe May 13, 2006 at 9:26 pm

"The US is one of the few countries in the world which publishes a detailed balance sheet of national wealth, produced quarterly in the Fed's flow of funds statistics. From this we find that the total assets belonging to the US private sector, net of all government and borrowing, both domestic and foreign, is not $12 trillion [the $12 trillion is a referenece to an earlier paragraph regarding annual GDP] but $52 trillion. Gross assets (before netting out household debts and the $2 trillion owed to foreigners) are $64 billion. This figure consists of tangible wealth (mostly housing) worth $26 trillion, equity in quoted companies worth $15 trillion, other financial corporate assets (such as bonds and deposits which also represent part of the net worth of the business sector) of roughly $9 trillion, plus $15 trillion of "other" assets, much of it represented by the value of national infrastructure plus the net worth of private non-quoted businesses.

"Offset against these $64 trillion gross assets are gross liabilities of $12 trillion, three-quarters of which are accounted by mortgage debts (incidentally, the assets and liabilities of the corporate sectors and the US government are cancelled out in these calculations, since the net value of companies ultimately belongs to their shareholders in the household sector, while the financial liabilities of the US government are equal to the government assets held by US households and the overseas sector)…"


ben May 14, 2006 at 4:49 am

Krowne: "Mortgage debt is much more worrisome"

For who? Presumably not the people choosing to take it.

Zephyr: "People are spending too much of what they earn."

Not in the opinion of the people doing the spending. They should know.

I always quietly laugh at the keeping up with the Jones theory of consumer debt – it is a silly argument unless you believe each person in the middle class does not know what consumption choices makes them makes them happy. However arbitrary middle class consumption choices seem, if keeping up with peers is what makes people happy, then forcing or encouraging people away from those choices cannot be helpful.

Bill Waddell May 14, 2006 at 4:39 pm

In the less than 20/20 hindsight department:

The press widely reported the impending tightening of the personal bankruptcy laws last Fall, practically urging people to file before the laws changed.

Then they reported long lines of people lined up at the various bankruptcy courts across the land getting their Chapter 7 filings in before the change took effect.

Then they all got whacked on the head and suffered total amnesia.

At year end, and still, they write stories about the economy gone to hell in a handbasket, as proven by the increase in personal bankruptcy filings.

Zephyr May 14, 2006 at 6:16 pm

Negative spin is inevitable… bad news is more compelling than good news.

Bankruptcies surged before the deadline and then dropped to a rate that is below where they had been all along.

Joe Calhoun May 15, 2006 at 9:02 am

While I agree with the general theme of the post, I wonder if a lot of the middle class angst has to do with the inflationary nature of this latest economic expansion. Those with more financial assets have a means for coping with inflation while those with less in financial assets have fewer ways to keep up.

I know that the general inflation stats don't reflect a huge inflation, but it seems to me that gold at $700 means something other than an increased desire for jewelry.

Any thoughts?

Robert Speirs May 15, 2006 at 10:50 pm

A lot of the things bought with credit card debt and other debt are undervalued. What's the real value of a computer that will last five years? What's the real value of a car that will last ten years in its fifth year, when it's paid off and it will provide five more years of transportation? Blue book value is about zip. We all know that's not true. Even a trip to Europe has lasting value. So if credit card debt is compared to the true value of all assets, it doesn't look so bad.

jomama May 17, 2006 at 7:25 am


What everyone here missed is this:

So many distractions, so little time.

Half Sigma May 17, 2006 at 5:04 pm

People judge how well they are doing compared to how well other people they come in contact with are doing. So it's not really relevant to people if someone in the 19th century had it worse than them.

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