The release of the Federal Reserve’s report on consumer credit was very telling. One of the continued themes that the economy was on its way to a real recovery was that the consumer was well into deleveraging the household balance sheet. This is important because one of the drags on economic growth has been a low savings rate due to high debt service levels. The chart below shows “real,” inflation adjusted, consumer debt relative to incomes. The red dashed line is the normalized growth trend of debt to incomes as a point of reference for the current levels of debt to incomes.
What is important to note, as shown more clearly in the next chart, is that economic growth expanded when debt was lower than the normalized trend. This led to higher savings rate which in turn fostered stronger economic growth. However, post 1980, as the trend of economic growth began to weaken, and interest rates fell, consumers began to leverage up with debt. The increase in debt service reduced savings rates from over 10% to less than 4% today.