An article in the FT caught my eye this week: Why dealing with the huge debt overhang is so hard by Martin Wolf. Wolf presented a number of charts analysing both US and UK debt over a number of years.
What was alarming was that in the UK, non-government debt has grown from roughly 80% of GDP in 1987 to over 400% today. This in itself is not new. The vast bulk of the growth has been down to the increase in borrowing by banks and other financial institutions. I have this comic Laurel and Hardy image in my head – “Another fine mess you’ve got us into!”
The fact that the banks have been borrowing like there was no tomorrow, to lend to customers who wanted to spend like there was no tomorrow, is no longer news. What did strike me though, was the figure for household debt. In 1987 this was less than 20% of GDP. Now it is 100%, comparable to the proportion of debt owed by the non-financial corporate sector. In other words, household debt is equivalent in value to the total national output in a year. Put another way: on average, households have spent in excess of their incomes as much as a year’s salary.
Think about this. Some people have little or no debt. That means that the average debt for those who do owe money is more than 100%. Arithmetically, this means that if those people were to reduce their expenditure to nothing (not practical, but let’s assume) then it would take more than a year to repay the outstanding loans they have run up. Granted, some of this debt will be mortgages spread over 25 or 30 years. Still, the implications for lifestyles and the economy in general are not bright.
It will take some effort for many people to reduce their standard of living to a point where they are living within their means, and this is assuming they still have an income. This alone will reduce demand from current levels. The negative feedback is being felt already as people are laid off from previously secure jobs. It will require a further effort to continue reducing living standards to a point where a regular surplus is being generated with which to repay outstanding loans. This will have a further negative effect on output and employment, with several years passing before balance is restored.
There are two issues here. One is that it is questionable that the consensus strategy for tackling the credit crunch (increase liquidity and expenditure) will be effective. Liquidity is not the problem any more so much as our ability to generate sufficient surplus with which to offset previous profligacy. Secondly, a change of attitude to wealth is both necessary and painful. The economy has been increasingly driven by a vast advertising budget, itself driven by a quest for ever-increasing corporate profits. Somewhere along the way we have forgotten that ultimately, we cannot consume more than we produce – at least, not without borrowing. If we ever, either as individuals or as an economy, spend more in a year than we produce, then sooner or later we must produce without spending in order to repay the debt. Unfortunately, the consequences of this can only be economic contraction and an adjustment of lifestyles to less than we have become accustomed. Hold on to your hats.