A sophisticated presentation from the New York Times, The Debt Trap. Especially the interactive chart of a century of debt and savings (under “lifetime”), that puts today’s staggering household debt burden into perspective.

One looks at that chart and says, wow, what a bull market in credit. Consumer credit in various forms has been around for millennia, but it seems like it really exploded after World War II. The effect of rising consumer credit and falling savings rates is to accelerate consumption.

Going back in time, people saved to buy a house. Then, as we move along the timeline, they just saved for a down payment, but expected to save the rest later as a function of their mortgage payment. Then they didn’t need to wait to save a down payment. Then they didn’t need to save the balance - to amortize the mortgage balance. Over time, they expected the appreciation of the house to not only cover the interest, but to supplement their incomes. At each step, people expected to be able to buy a house earlier and earlier in the life cycle of their household. Price also became less of an issue at each step, and so houses became bigger and more costly. Most recently, price sensitivity even became inverted, as a more expensive house was seen to generate more dollars of appreciation and bigger tax savings.

We see the same phenomenon in other lifetime purchases, such as a college education, which have clearly gone through similar structural shifts. Particularly the price-raising part, in the case of colleges. So we had more and more debt, moving earlier and earlier in the household life cycle over a long period of time.

If you drew a household life cycle as a timeline, you could divide it into three segments, a savings segment, a debt servicing segment and a retirement segment. As debt has increased, the debt servicing segment has spread out to take over the other two segments. When we reached the point where a newly formed household expected to buy a house immediately, in addition to servicing their student loans, and would likely end up at retirement with outstanding debt still to service, we reached some kind of a limit. “You can’t get blood out of a turnip”.

I was watching the Suze Orman show last night. The show has this “can I afford it?” segment. I was particularly struck by the guy who was making $7,000 a month who wanted to buy a new Bentley convertible for $212,000. He was, admittedly, debt free except for an existing car lease of, I think it was, $695. He claimed to be able to finance the Bentley at 6.5%. I fired up my trusty HP-12C which shows that the monthly payment on a 48-month loan would be $5027.57. So his total car payments would be $5,700 or so. And then, of course, there are operating costs. How was he going to eat? People just do not understand the implications of buying on credit.

Consumption has to balance with income over the household life cycle. That is, if I buy a Bentley Continental, I have to cover the depreciation on that puppy from my income or my savings. So that may mean less money to spend on other things now, or I may choose to burn my savings and have less to spend in retirement. People have chosen to burn their savings on consumption, in general. That lack of savings for retirement is the demographic part of the debt trap that many analysts have observed.

The other part of the debt trap is that, so long as the debt servicing part of the lifecycle continues to expand, consumption is being pulled forward. But it eventually reaches a limit, when consumption is pulled so far leftward that it cannot move any further. I would argue that we have reached that point. Then aggregate debt cannot expand further than the present value of aggregate income for all households. In effect, real consumption cannot expand faster than real income. In fact, it has to shrink because retirement savings are clearly insufficient. As the baby boomers move through, the average household in the mix becomes older - further along the timeline - and transfer payments from younger households are going to have to be made in order to feed and house the elderly who have over-consumed and lack savings to sustain them.

The debt-servicing segment of the household life cycle will have to be shrunk to some equilibrium value, on average deferring consumption. As this equilibrium point is found, aggregate consumption will fall drastically. The tailwind that increasing debt has given to economic growth will reverse to a howling headwind. Other developed countries will suffer similar circumstances. Countries, such as China, which are in a different phase of economic development, still emphasising savings over debt, will be moving to equilibrium from the other side, giving them much stronger internal growth.

But, you retort, all this debt is just paper accounting, isn’t it? It is just money that we owe to ourselves, after all. The economy has been pumping out all the goods and services that we need, why won’t it continue to do so, indefinitely? Sure, savers aren’t going to get rewarded in goods and services as they expected, because the borrowers won’t be repaying. But, over all, why should consumption fade when the capacity to produce all the SUVs and cellphones and bottled water that people want is obviously there? Manufacturing productivity keeps rising, doesn’t it?

Ah, I respond, then let me count some of the ways that productive capacity will decline.

• Malinvestment. Over this long secular trend, massive investment has been made in things like housebuilding and the associated financial services that will not be needed in the future. Shifting the economy to produce other things will subtract productive capacity from the economy while the shift is being made. We have enough SUVs. And probably enough cellphones and bottled water, too.
• Underinvestment. Bridges are falling down and highways are cracking. Why is the price of oil so high? Because of insufficient investment in energy production. Energy production capacity is declining, which is affecting the supply of goods and services in that they become scarcer and hence more costly. Inadequate maintenance of infrastructure saps productive capacity. Everything is wearing out and not being replaced. Another shift in the economy to produce different goods and services.
• Overconsumption (or underproduction). The US is no longer self-sufficient in anything. We consume more than we can make. It is simply untrue to say that this debt is money we owe to ourselves, much of it is owed to foreigners who have delivered goods and services to the US. All you need to see is the impact of defaults on foreign banks and investors reported in the press almost daily. That debt needs to be serviced, and it is serviced by goods and services that we send overseas in return for those that we have received in the past. Production will shift to increase emphasis on goods and services our foreign creditors will want.

In summary, the economy will change, and will lose productive capacity while changing. The change will be massive, as it will represent a reversal in a hundred-year-old trend. It is the end of an empire built on credit.

Bloomberg writes:

One of the last holdouts in consumer spending — luxury- goods purchases — may be collapsing under the weight of a sluggish and potentially contracting U.S. economy.

Moving from cognitive bias to just plain old schadenfreude, the NYT documents the whining of the heavy metal owners coping with $100+ tankfuls.

I have no sympathy, in fact the reverse. To a considerable extent, the hgh price of gasoline today is due to the wasteful behavior of these people. Their self-esteem issues and status striving have cost me thousands of dollars over the years. Bring on the European $10 gallons and get these ludicrous and ungainly behemoths off the road once and for all.

Another echo of the past. From the Detroit Free Press:

When Chrysler announced plans to cut 12,000 jobs in November — on top of 13,000 over three years — executives were assuming Americans would buy fewer vehicles in 2008 than in any year in a decade, only about 15.5 million. Nardelli said that “conservative estimate” was pretty close for the first three months of the year.

But sales were 7% to 8% below that rate in April and May. And so far in June, he said, J.D. Power and Associates and Citigroup are seeing a sales pace that is almost 20% lower — only 12.5 million vehicles per year.

The flashback (from PBS):

Spring: The American economy shows ominous signs of trouble. Steel production is declining, construction is sluggish, car sales are down, and consumers are building up high debts because of easy credit. Yet the stock market continues its upward momentum, heedless of real economic indicators.

A little good news. General Motors signalled that the end was near for the Hummer product line.

Wagoner said GM is reviewing its Hummer brand and could sell the military-derived SUV line, which has become synonymous with gas-guzzling excess and has hurt GM’s image at a time when consumers are demanding more fuel efficiency.

Gas-guzzling excess? Well with a basic curb weight of over 6,600 pounds, what do you expect? From what I understand, you expect somewhere between 8 MPG in the city and 14 or so on the highway. A classic symbol of conspicuous consumption. Big. And tall, so you can look down on your inferiors, the little people scuttling around in their Hondas. I’ve always thought it would be easier if you could just buy a status badge from the government, like $1 million for a bronze, $10 million for a silver, $100 million for a gold and so forth. Then you could just wear it on your lapel and you wouldn’t have to spend money on Hummers or Porsches, you could just buy safe, comfortable and efficient transportation. Everybody who saw the badge would know you had paid a lot of money for it. As a badge-wearer, you could sneer at the badgeless peasantry. Or patronize the wearers of lesser badges. The revenue from badge sales would help keep taxes low. Resource consumption would be minimal. Sounds like a win-win to me. I mean, this isn’t a new idea. Before there were Hummers, many civilizations had sumptuary laws that limited the wearing of certain articles of clothing, or colors or fabrics, to visually mark social status. Relatively cheap, and successful. Why not? Instead of the huge grilles and front ends of the pickup trucks and SUVs, why not just bring back the well-stuffed codpiece?