ECONOMY'S HOME RUN FAMILIES' NET WORTH IS HIGHER AND CONTINUES TO CLIMB.

Byline: Robert Krol Local View

WE produce to consume. Yet, every holiday season I hear complaints that we consume too much. The fear is that excess borrowing will eventually undermine the economy.

But have consumers borrowed more than they can handle? Will consumers be unable to repay their loans, causing widespread defaults and economic collapse? Such predictions are common but wrong.

Family net worth is far higher now than it was 10 years ago, despite the stock-market collapse. Household debt service has risen, but not dramatically so. More important, productivity growth will raise income in the future, allowing consumers to pay off their debts.

Approximately two-thirds of what we produce each year is consumed. Critics of our consumption-driven economy often point to rising household debt as a serious problem and a sign of future financial trouble. However, growing consumer debt is a poor proxy for the financial status of families. A better measure is net worth or debt service compared to income. From this perspective, the average family is in good financial shape.

The current record levels of home and stock ownership are making Americans wealthier. The Federal Reserve estimated that inflation-adjusted median family net worth was $80,700 in the fall of 2002 (this figure captures most of the stock-market collapse). Given the significant gains in stock and home values in 2003, this figure understates today's net worth. This compares to a median family net worth of $61,300 in 1992.

The increase in net worth occurred across all income groups. However, it was greatest for the richest 20 percent and the poorest 20 percent of Americans. The primary implication of net-worth growth is that families are accumulating assets faster than liabilities, placing themselves in a stronger position to both take on and service debt through time.

The Federal Reserve measures our debt burden as the ratio of debt payments to disposable personal income. Both mortgage and consumer debt payments are included. The most recent estimate of the Fed's basic debt service ratio reached 13.3 percent in the second quarter of 2003. Not surprisingly, it increased some during the recent recession.

To put this measure in longer-run perspective, the debt service ratio was 10.8 percent ten years ago.

The debt service ratio has fluctuated between 10 percent and a little more than 13 percent since 1980. It exceeded 12 percent during the 1980s without causing economic havoc. Consumers are perfectly capable of managing their debt service over time.

That today's debt service ratio is at the top of its long run trend makes sense in light of recent trends in productivity growth. The debt service ratio grew during the 1990s information technology boom. Improvements in technology increase productivity and income. With significantly higher income down the road, families reasonably take on greater debt.

The increased borrowing today and greater debt service is a rational response to higher expected income in the future. While it's certainly true that individual families can borrow to excess and get into financial trouble, for the economy as a whole, greater debt and debt service today make economic sense. We are simply shifting a share of our growing future income to the present, consuming some of the hard-earned future gains of the information technology boom today.

A common refrain is that Americans live in a ``credit-card society,'' in which excess borrowing will eventually undermine the economy. In reality, American families are becoming wealthier. Given the growth prospects of the U.S. economy, consumers will have little problem serving their debt in the future.