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structural shifts. First, the economy as a whole has become much more
indebted. Output rose eight times between 1975 and 2007. But the total
volume of debt rose a staggering 20 times, more than twice as fast. The
total debt-to-GDP ratio surged from 155 percent to 355 percent. Second,
almost all this extra debt has come from the private sector. Take a look at
Chart 2 (https://customers.reuters.com/d/graphics/USDEBT2.pdf).

Despite acres of newsprint devoted to the federal budget deficit over the
last thirty years, public debt at all levels has risen only 11.5 times since
1975. This is slightly faster than the eight-fold increase in nominal GDP
over the same period, but government debt has still only risen from 37
percent of GDP to 52 percent.

Instead, the real debt explosion has come from the private sector. Private
debt outstanding has risen an enormous 22 times, three times faster than the
economy as a whole, and fast enough to take the ratio of private debt to GDP
from 117 percent to 303 percent in a little over thirty years.

For the most part, policymakers have been comfortable with rising private
debt levels. Officials have cited a wide range of reasons why the economy
can safely operate with much higher levels of debt than before, including
improvements in macroeconomic management that have muted the business cycle
and led to lower inflation and interest rates. But there is a suspicion that
tolerance for private rather than public sector debt simply reflected an
ideological preference. 

THE DEBT MOUNTAIN
The data in Table 1 (https://customers.reuters.com/d/graphics/USDEBT3.pdf)
makes clear the rise in private sector debt had become unsustainable. In the
1960s and 1970s, total debt was rising at roughly the same rate as nominal
GDP. By 2000-2007, total debt was rising almost twice as fast as output,
with the rapid issuance all coming from the private sector, as well as state
and local governments.

This created a dangerous interdependence between GDP growth (which could
only be sustained by massive borrowing and rapid increases in the volume of
debt) and the debt stock (which could only be serviced if the economy
continued its swift and uninterrupted expansion).

The resulting debt was only sustainable so long as economic conditions
remained extremely favourable. The sheer volume of private-sector
obligations the economy was carrying implied an increasing vulnerability to
any shock that changed the terms on which financing was available, or
altered the underlying GDP cash flows.

The proximate trigger of the debt crisis was the deterioration in lending
standards and rise in default rates on subprime mortgage loans. But the
widening divergence revealed in the charts suggests a crisis had become
inevitable sooner or later. If not subprime lending, there would have been
some other trigger.

WRONGHEADED POLICIES
The charts strongly suggest the necessary condition for resolving the debt
crisis is a reduction in the outstanding volume of debt, an increase in
nominal GDP, or some combination of the two, to reduce the debt-to-GDP ratio
to a more sustainable level.