Wikinvest Wire

Most misunderstood chart of all time

Tuesday, November 11, 2008

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.

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 article).

But, as shown below, you can construct almost the exact same curve when you hold debt constant during this period.
IMAGEAs 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 a 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.

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Anonymous said...

With regard to both debt to GDP and savings, we are beginning the crisis in a far weaker state than in 1930. Also, the constraints on currency devaluation are similarly weaker. I am trying hard to understand the deflation argument but cannot see how this concludes with a strong dollar.

Adam said...

Tim - you should check out Steve Keen's debtdeflation blog.

Greg said...

Can you imagine what that graph might look like if our GDP starts dropping? Of course, I don't think the government accounts for inflation properly so the debt build-up is likely worse than it appears in the graph.

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