The Most Misunderstood Chart of All Time

With the increasing number of comparisons between the recent economic turmoil and the Great Depression, this chart is showing up more and more. In my humble opinion, it is one of the most misunderstood charts of all time.
Why?

The upward spike in the 1930s had little to do with "Debt Buildup" as so many claim - it was almost completely a result of a contracting economy!

The chart above is from a recent Martin Weiss article about preventing another depression, but the same curve has appeared in thousands and thousands of places over the years. It is typically presented as evidence that the recent accumulation of debt has only been seen once before - back around the time of the Great Depression.

But what this chart really shows is the ratio of debt to GDP - that's two variables - and as anyone with a rudimentary understanding of mathematics knows, either the numerator or the denominator can cause a ratio to change.

In this case it's the denominator [GDP] not the numerator (debt) as one might be inclined to think when looking at the title that sits atop the curve.

Along with this chart, you typically see commentary like, "the debt build-up in the U.S. today is far greater than it was on the eve of Great Depression I" (actually, that's right from Weiss's article).

But, as shown below, you can construct almost the exact same curve when you hold debt constant during this period.
As everyone should know, the real story of the 1930s was not debt, but economic contraction that occurred at rates of -8 percent, -6 percent, and then a whopping -14 percent in 1932.

Early in the last century the buildup in debt occurred during the 1920s, but since a goodly amount of economic growth came along with that expansion in debt, you couldn't discern a problem from looking at that decade in the first chart above.

Sound familiar?

Then, as now, the problems occur when the growth stops but the debt lingers.

Comments

[Steven Hansen:]

this is a graph of the proverbial straw which broke the economy's back. this is a debt bubble to go with the housing bubble to go with the equities bubble.

2008 Nov 12 05:04 AM

[Jack K:]

So massive debt is not bad?
Come on.

2008 Nov 12 07:19 AM

[je:]

Debt is debt-it is either repaid or it is in default. Getting companies producing will not remove the burden of debt unless they can produce multiples of the money borrowed and reduce individual taxes to zero so that it can be spent. I believe that people are transitioning to the savings mode - now what?

The debt on these treasuries is not sustainable. It will be paid through the monetization or not at all. Maybe foreign holders of this debt realize this. They will be losers in either case.

I think maybe China's stimulus plan will be paid for with the US treasuries that they hold. What will that do to the dollar if I am corect? What will we do to the dollar through the printing press if they don't?

I read that one of China's economist has said that the dollar will be the worlds currency for years to come. I think he is talking his book so that China can start dumping treasuries at a high dollar value. They know that there is further selling by hedge funds that will occur and the dollar will benefit from that - what an opportunity for them to sell in to.

All of the accounting voodoo might postpone the moment where the rubber meets the road but it will not eliminate that moment.

Right now they are withholding money from the people through the Paulson crime syndicate by giving money only to favorites and taking out banks to feed to the belly of the beast JP Morgan, Citi, Bank of Am., and Wells and telling you that there is a deflationary problem. This is what the Bloomberg suit is about.

Wait until they are forced to start lending and they will be if not now they will when the new Congress starts to take action.

And one question on GM - are they going to use the bailout for workers herein the US or are they taking it overseas? How much good will that do?

2008 Nov 12 09:09 AM

[oldgoldbug:]

-8%,-6%,-14%= economic activity at 74.37%. This during a time when we actually made things and didn't just consume. What kind of decline are we looking at with an economy built on home remodeling, shopping malls, cable TV, diet soda, etc? 10% of the economy is manufacturing and a lot of that is tied up with F, GM Chrysler etal?
Thank you for the information and point of view; it helps to explain why some charts look so absolutely awful.
Also explains why Bernanke is so resolute to do everything in his power to avoid a repeat. I think he is a smart guy, but perhaps this is going to be too much even for the FED and central banks.

2008 Nov 12 09:27 AM

[300mph:]

So what's you point? Current spike caused by higher debt or lower GDP? Either way it's a disaster!

2008 Nov 12 11:16 AM

[John Lounsbury:]

The entire question of whether debt is good or bad comes down to one factor: for what is the debt incurred?

Debt that is taken on for consumption is a disaster waiting to happen. That is the situation we are now experiencing. Debt has been incurred to buy things that have been consumed (oil, automobiles, houses, vacations, etc.). I include houses because they are not tools of production (see next paragraph). The debt is repaid by taking on additional debt. This defines the structure of a Ponzi scheme.

Debt that is taken on to build tools of production is good debt. This debt is repaid with the future production and future wealth is created.

The important factor is not the amount of debt but what the debt is used for. Recognition of this is implied in oldgoldbug's comment.

2008 Nov 12 11:27 AM

[Mr.G:]

wow - the comments pretty much say it all - and I agree with 99% of them
although Weiss is a permabear and usually gets his but kicked by a rebounding stock market -I cant help but think he may be right this time -

I read a saying the other day it said "bulls never look at history or completely disregard it saying the worst could never happen ..." ( I added this part)
"...and bears disregard bulls in their fundamental analysis" That is why things are never as bad as they fundamentally should be

2008 Nov 12 12:09 PM

[TucsonSpike:]

Interesting analysis, but my observation is that we are in a period of economic contraction and are launching from a hugely higher debt position. It would seem that the result would be much worse than the Great Depression.

2008 Nov 12 02:04 PM

[Engineer:]

Great observation Tim.

I think the other interesting thing this graph shows, is that in effect, the productive capability of the nation is more and more flowing to debt since money became fiat.

It is also interesting to see in this graph that post-fiat recessions (early 1980s, 1990s and 2000s) are mere blips compared to the 1930s.

I think this trend ends up in one of two places: you hit a theoretical max and oscillate about this max, or have hyperinflation and all debts are cleared.

2008 Nov 12 05:22 PM

[VintonCounty:]

Readers' minds are being sidetracked by the irrelevant discussion of the significance of the 1934 peak. The graph's purpose is to show that aggregate interest-bearing debt, relative to GDP, is at record high level. That conclusion remains, regardless of whether you think the 1934 peak is misleading.

2008 Nov 13 01:37 AM

[SAF:]

The point of the curve is not that debt doesn't matter but that it is much worse than ever before by any measure.

2008 Nov 15 03:20 PM

[John Slater:]

Consider looking at the chart in another way.

1997 was the equivalent of 1929 for purposes on analyzing the chart. We have been in a negative economic event (no good historical term for it) ever since. the runup from 230% to 360% is parallel to the runup from 1929 to 1934 as the economy has tried to address the shocks of the period, but failed and as a result debt has soared in relation to income. doesn't look exactly the same as in the because your friend Mr. Greenspan pushed a lot of his crack at the economy to keep the deflation from happening sooner. Looked at optimistically we may be somewhere near 1934 in terms of the chart. Of course it took six more years for the economy to dig itself out.

2008 Nov 17 12:18 AM