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Household deleveraging is a very healthy indicator

The Fed's latest data on households' debt service burdens (as of Dec. '09) came out just the other day, and the news continues to be good. Households are reducing their debt burdens, which are best measured as shown in the chart by comparing total debt service payments to total disponsible income. Indeed, by this measure, household financial burdens are no higher today than they were in the mid-1980s. (Measures that compare household outstanding debt to income are flawed, because they compare the stock of debt to the flow of income; it only makes sense to compare the flow of debt service to the flow of income: to compare monthly debt payments to monthly income.)

By reducing their debt servicing burdens, households are expressing a strong desire to increase their holdings of money. (Reducing one's debt is equivalent to increasing one's holdings of money, just as increasing one's debt is equivalent to reducing, or shorting, one's exposure to money.) This is the phenomenon that the Fed has been fighting for the past year or so. The increase in money demand on the part of households and businesses has been so huge that the Fed has had to take extraordinary measures to increase money supply, via a massive expansion ($1.25 trillion) of bank reserves.

As an objective observer of the goings-on in the economy, I can't find anything in this data or in this chart that paints a worrisome picture for the economy. If the financial crisis of 2008 was brought on by excessive borrowing, we have surely corrected the underlying problem by now.

As a contrarian, I would note that with the deleveraging trend so patently obvious, and with the Fed so blatantly accommodative, it is probably not a bad idea to swim upstream and increase one's leverage these days. Which is equivalent to saying that holding cash is such a mainstream strategy—and so minimally remunerative—that it is embarrassing. See my posts over the last year on this same subject here.

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