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YOU DECIDE: Are we overwhelmed with debt?

January 11, 2008

MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

Dr. Mike Walden
Media representatives: For a black-and-white or color copy of this photo, call 919.513.3127 or e-mail dave_caldwell@ncsu.edu.

A common resolution for the new year is to get our personal finances in order.

We're told to save more and borrow less so more money will be available for our children's college education, our retirement or any of the other good things in life we might want down the road. These same resolutions are also often recommended for the government, as people worry about public debt piling up.

And there certainly appear to be ample reasons to be concerned about both a lack of saving and a build-up of debt. In the early 1990s, households were saving between 8 and 10 percent of their disposable income, a rate most financial experts say is the minimum required. In 2006, this saving rate was down to only 1 percent.

At the same time, average (median) debt held per household increased almost 40 percent from the early 1990s to the mid-2000s, and this is even after adjusting for general inflation. There was also a jump in government debt. Federal government debt (the so-called "national debt") per household and after inflation rose 20 percent over the same period.

However, looking at saving and debt in isolation may result in some distorted conclusions. In particular, economists argue it's important to look at the ability of a household or government to carry debt. It's also vital to consider all types of saving.

So while the average household increased its debt 40 percent from the early 1990s to the mid-2000s, median household income (again after taking out inflation) rose 20 percent. This makes the increase in household debt look a little better, but still, the gain in debt outstripped the gain in income.

Yet believe it or not, the ability of the federal government to carry additional debt looks manageable when the country's income situation is considered. Since the early 1990s, the amount of income earned by everyone in the country has risen by almost exactly the same percentage as the increase in the national debt. Stated another way, the "burden" of the national debt, as a percentage of national income, is the same today as it was almost 20 years ago.

There's one more wrinkle to the saving/debt story.

Experts say the best way to judge the financial position of a household or business is to look at their net worth. Net worth is simply the value of investments (also called assets) minus the value of debt (also termed liabilities). By this concept, someone with a large debt can still be financially sound as long as the value of their investments is substantially larger.

When viewed from the perspective of net worth, the financial situation of U.S. households looks much different. Indeed, it looks much better.

Since the early 1990s, the net worth (after inflation) of the average household has actually increased, and by a healthy 40 percent. This means that while household debt increased, the value of household investments increased even more. Also, the gain in net worth has been across the income board, with the lowest-income households achieving a 44 percent gain while the highest-income households had a 92 percent increase.

Indeed, many economists think the gain in household net worth can explain why our saving rate is low. Net worth can be improved in two ways: by people saving money out of their paycheck and putting it into investments or by the investments they already own increasing in value. If one way is increasing, people often take a break from the other.

In fact, a study from the Federal Reserve found almost a one-to-one relationship between gains in the stock market since the early 1990s and the decline in the saving rate. As the stock market has boomed - on trend - households have let these gains bolster their net worth, and consequently they've not been compelled to save from their paychecks.

Of course, everything I've stated is looking back. The future could be much different.

Some analysts see future government debt rising much faster than national income. Also, if the stock market sputters and falls into a long decline, household net worth will drop unless saving increases.

But from the perspective I've outlined here, maybe you'll decide our financial situation - to date - isn't as dire as commonly thought!

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University's College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his You Decide column every two weeks. Earlier You Decide columns are at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm

Related audio files are at http://www.ces.ncsu.edu/depts/agcomm/writing/walden/index.html

Posted by Dave at January 11, 2008 08:35 AM