Challenges the official outlook for HH debt vulnerability
The key chart
Share of UK households with high, adjusted DSRs on mortgage debt (Source: BoE; CMMP)
The key message
A “significant monetary policy response” from the Bank of England poses an equally significant risk to the Bank’s relatively sanguine view of household debt affordability and financial stability, expressed less than 90 days ago.
In its July 2022 “Financial Stability Review” (FSR), the Bank of England forecast that the share of UK households with high, adjusted debt service ratios would increase in 2023, but “would remain significantly below the peaks seen ahead of the GFC.”
In response to questions at the FSR’s launch, Sir Jon Cunliffe, the Deputy Governor for Financial Stability, indicated that rates would have to rise significantly (200-500b) above current market expectations for the bank rate (3% at the time) for the share to reach previous highs (see “Financial inequality and debt vulnerability.”).
Fast-forward a mere 85 days and Huw Pill, the Bank’s chief economist, is suggesting that the Bank is likely to deliver a “significant monetary policy response” to protect sterling and fight rising inflation. Some financial market participants are arguing already that interest rates could reach 5.5% to 6% in 2023. In response, some UK mortgage lenders are pulling mortgage deals, citing the lack of certainty on how far interest rates may have to rise.
More importantly, if the latest market forecasts and the Bank’s earlier debt vulnerability forecasts turn out to be correct, rates will reach the levels at which the share of households with high, adjusted debt service ratios – those who are typically likely to struggle with debt repayments – could return to pre-GFC highs in 2023.
Please note that these summary comments are abstracts from more detailed analysis that is available separately.
1Q22 Public and private sector debt ratios (%GDP) by country (Source: BIS; CMMP)
The key message
With global debt levels at a new, record high of $230 trillion and questions regarding debt sustainability dominating headlines, there are three key risks associated with popular investment narratives. The first is to treat the level of debt and the level of indebtedness synonymously. The second is to ignore the key structural shifts in global debt that have taken place since the GFC. The third is to dismiss the considerable differences that exist between the breakdown and level of indebtedness at the country level. The final risk is compounded by the fact that conventional macroeconomics typically ignores private sector debt while seeing public debt as a problem.
Debt versus indebtedness
While the level of total debt is at a new high, the level of indebtedness (261% GDP) is 30ppt below its 4Q20 peak (291% GDP). Similarly at the country level, the US and China collectively account for just over half of outstanding global debt but neither rank among the top-ten most indebted global economies. In contrast, Japan and France both rank among the top-five global economies in terms of their share of total debt and their level of indebtedness – yet, how often is France included in debates over debt sustainability?
Structural shifts
The first important structural shift in the post GFC period is the one away from relatively high-risk household (HH) debt towards lower-risk government debt driven largely by US and UK debt dynamics. The second is the “apparent” shift towards EM debt. In reality, this is a China-debt story rather than an EM debt story, however. EM ex-China’s share of global debt is largely unchanged since the GFC.
Country-level differences
Finally, considerable differences exist between the breakdown and levels of global debt ratios at the country level. Six of the 43 BIS reporting nations have above average private and public sector debt ratios – Japan, Singapore, France, Canada, Belgium and Portugal. A further 14 reporting nations have above average private sector debt ratios but below average public sector debt ratios – Hong Kong, Luxembourg, Sweden, Switzerland, the Netherlands, Denmark, Norway, South Korea, China, Ireland, Australian, Finland, Thailand, and New Zealand.
The key point here is that conventional macroeconomics typically ignores private debt while seeing public sector debt as a problem.
Note in this context, the emphasis that is typically placed on debt sustainability in the US, UK, and Italy despite the fact that these three nations are among the six reporting nations that exhibit above average levels of public debt but below average levels of private sector debt.
As noted previously, the US, Italy and Germany are also the only three advanced economies that have both household and corporate debt ratios below the levels that the BIS consider detrimental to future growth. A topic that I will return to in subsequent posts on private sector debt dynamics.
1Q22 Global debt dynamics – the charts that matter
Debt versus indebtedness
Trends in total debt (USD billions, LHS) and debt ratios (%GDP, RHS) since 1Q08 (Source: BIS; CMMP)
The outstanding stock of global debt hit a new, record high of $230 trillion at the end of 1Q22, according the latest BIS statistics (see chart above). The level of global indebtedness, expressed as the level of debt to GDP, has fallen from its 4Q20 peak of 291% GDP to 261% GDP, however.
Note that the level of debt and the level of indebtedness are not synonymous.
Top-ten ranking of BIS reporting nations by total debt (USD billions, LHS) and cumulative market share (%, RHS) as at end 1Q22 (Source: BIS; CMMP)
The US and China collectively account for over half of global debt but neither economy ranks among the top-ten most indebted global economies. At the end of 1Q22, the US and China accounted for 28% and 23% of the outstanding stock of global debt respectively (see chart above). In terms of indebtedness, the US and China rank only #16 and #13 globally, however (see chart below).
In contrast, Japan and France both rank among the top-five global economies in terms of their share of total debt (see chart above) and their level of indebtedness (see chart below) – yet, how often is France included in debates over debt sustainability?
Top-ten ranking of BIS reporting countries by total debt ratio (% GDP) (Source: BIS; CMMP)
Structural shifts
The first important structural shift in the post GFC period is the one away from relatively high-risk HH debt towards lower-risk government debt driven largely by US and UK debt dynamics. At the end of 1Q08, corporate (NFC), HH and government debt accounted for 38.7%, 31.5% and 29.9% of total debt respectively. At the end of 1Q21, these respective market shares were 38.7%, 24.9% and 36.5%. In other words, while the share of NFC corporate data remains unchanged there has been a clear shift away from HH to government debt.
Structural shifts in global debt (% total) since 1Q08 (Source: BIS; CMMP)
As highlighted in “Challenging flawed narratives” earlier this month, the structure of US debt is now the mirror image of its pre—GFC structure. This follows the shift away from HH debt towards government debt and the passive deleveraging of the US HH sector (see charts below repeated from previous post).
Shares of outstanding US non-financial debt by sector (Source: FED; CMMP)Trends in US HH debt ($ tr) and HH debt ratio (% GDP) (Source: FED; CMMP)
The second is the “apparent” shift towards EM debt. At the end of 1Q08, advanced economies and emerging markets accounted for 84% and 16% of outstanding global debt respectively. At the end of 1Q22, these respective shares had changed to 64% and 36% (see graph below).
Trends in advanced and emerging markets shares of total debt (% total) (Source: BIS; CMMP)
In reality, this is a China-debt story rather than an EM debt story, however. EM ex-China’s share of global debt is largely unchanged since the GFC. In contrast, China’s share of total global debt has increased from 5% at the end of 1Q08 to 23% at the end of 1Q21 (see chart below and “Global debt dynamics – V“)
Trends in China and EM ex-China market shares of total debt (% total) (Source: BIS; CMMP)
Country-level differences
Finally, considerable differences exist between the breakdown and levels of global debt ratios at the country level (see chart below). Six of the 43 BIS reporting nations have above average private and public sector debt ratios – Japan, Singapore, France, Canada, Belgium and Portugal (the top RH quadrant). A further 14 reporting nations have above average private sector debt ratios but below average public sector debt ratios – Hong Kong, Luxembourg, Sweden, Switzerland, the Netherlands, Denmark, Norway, South Korea, China, Ireland, Australian, Finland, Thailand, and New Zealand (the top LH quadrant).
The key point here is that conventional macroeconomics typically ignores private debt while seeing public sector debt as a problem.
1Q22 Public and private sector debt ratios (%GDP) by country (Source: BIS; CMMP)
Note in this context, the emphasis that is typically placed on debt sustainability in the US, UK, and Italy despite the fact that these three nations are among the six reporting nations that exhibit above average levels of public debt but below average levels of private sector debt (the bottom RH quadrant above).
As noted previously, the US, Italy and Germany are also the only three advanced economies that have both household and corporate debt ratios below the levels that the BIS consider detrimental to future growth. A topic that I will return to in subsequent posts on private sector debt dynamics.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Four challenges to the “over-indebted US economy” narrative
The key chart
Share of outstanding non-financial debt by sector (Source: FED, CMMP)
The key message
The latest “Financial Accounts of the United States” published by The Federal Reserve at the end of last week challenges the popular, but flawed, narrative of an “over-indebted US economy”.
This narrative typically focuses on the outstanding stock of US nonfinancial debt, which hit another new high of $67.6 trillion at the end of 2Q22. Mistakenly, however, it ignores:
The significant shift away from private to public sector debt. The structure of US debt is now the mirror image of its pre-GFC structure following the shift away from relatively high-risk household (HH) debt towards lower-risk government debt (see key chart above)
The on-going, passive deleveraging of the HH sector. The HH debt ratio has fallen from its peak of 99% GDP at the end of 1Q08 to 75% at the end of 2Q22, very slightly above its post-GFC low
The relatively low levels of business (NFC) and HH indebtedness in a global context. The US is one of only three, BIS-reporting advanced economies with both NFC and HH debt ratios below the BIS threshold limits (above which debt becomes a constraint on future growth)
Key distinctions between public and private sector debt and their implications. Government debt represents financial wealth for the private sector, hence its position on the asset side of the private sector’s balance sheet. Furthermore, governments do not face the same constraints as the private sector. As a currency issuer, the US government cannot become insolvent in its own currency since it can always make payments as they come due in its own currency.
CMMP analysis believes that it is more accurate to view public sector debt as money in circulation rather than as debt in its more widely-held sense. In this context, “the idea of having to pay back money already in circulation [another feature of the flawed narrative] makes little sense.” (Alfonso, 2020. “Does the National Debt Matter?”)
Challenging flawed narratives
Trend in outstanding stock of US non-financial debt in $ trillions (Source: FED; CMMP)
According to the latest financial accounts, the outstanding stock of US nonfinancial debt reached $67.6 trillion at the end of June 2022 (see chart above).
Federal debt of $26.3 trillion accounted for 39% of total debt, followed by NFC debt of $19.5 trillion (29% total), HH debt of $18.6 trillion (27% total) and state and local debt of $3.3 trillion (5% total). The total debt ratio fell to 272% GDP, down from 307% GDP in 2Q20 at the height of the COVID-19 pandemic.
Share of outstanding non-financial debt by sector (Source: FED, CMMP)
The structure of US debt is now the mirror image of the structure that existed before the global financial crisis (GFC). At the end of 2Q07, HH debt accounted for 43% of outstanding nonfinancial debt, followed by NFC debt 30% and public sector debt (federal, state and local) 27%. Today (at the end of 2Q22), public sector debt accounts for 44% of outstanding debt, followed by NFC debt 29% and HH debt 27%. This represents a very significant structural shift away from relatively high-risk HH debt towards lower-risk government debt in the post-GFC period (see chart above).
Trends in HH debt ($ tr) and the HH debt ratio (% GDP) (Source: FED; CMMP)
The HH debt ratio has fallen from a peak of 99% GDP at the end of 1Q08 to 75% at the end of 2Q22 (see chart above). The peak level was 14ppt above the threshold level of 85% GDP above which debt is believed to be a constraint on future growth. The current level is slightly above its post-GFC low of 74% at the end of 4Q19.
The post-GFC period has been one of passive HH deleveraging.
Trends in HH and NFC debt ratios (Source: FED; CMMP)
The US is one of only three BIS-reporting advanced economies that has both HH and NFC debt below the maximum BIS threshold limits (along with Germany and Italy). The NFC debt ratio currently stands at 78% GDP, down from a recent high of 91% GDP at the end of 2Q20. For reference, the BIS maximum threshold limits for HH and NFC debt are 85% GDP and 90% GDP respectively (see chart above).
As shown in the chart below, the US private sector debt ratio of 153% GDP is now only slightly above the 145%-150% GDP range that characterised much of the past decade up until the COVID pandemic.
Trends in private sector debt ratio (% GDP) (Source: FED; CMMP)
Important distinctions exist between private sector and public sector debt, including:
While private sector debt is debt sitting on the liability side of the private sector’s balance sheet, government debt represents financial wealth for the private sector and sits on the asset side of the private sector’s balance sheet
As currency users, HHs and NFCs face obvious constraints on their levels of debt. “Taking on too much debt can, and does, lead to bankruptcy, foreclosure, and even incarceration” (Kelton, 2020)
In contrast, as a currency issuer, the US government cannot become insolvent in its own currency since it can always make payments as they come due in its own currency
CMMP analysis believes that it is more accurate to view public sector debt as money in circulation rather than as debt in its more widely-held sense. In this context, “the idea of having to pay back money already in circulation [another feature of the flawed narrative] makes little sense” (Alfonso, 2020. “Does the National Debt Matter?”).
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
UK household card spending by type in relation to pre-pandemic levels (Source: ONS; CMMP)
The key message
The message from the UK money sector remains one of resilient consumer spending, despite rising inflation and falling real incomes. UK households are reallocating their spending towards getting to work and staple items at the expense of spending on delayable goods and socialising, rather than reducing spending entirely. This matters because household spending accounts for 60p in every pound of UK output. The recent recovery in spending on delayable goods since mid-August is also a positive sign, although this key indicator of excess savings returning to the economy remains below pre-pandemic levels.
Re-allocating rather than reducing
In recent presentations on the outlook for UK and euro area household dynamics and consumer credit, I noted that households typically either reduce their spending and/or reallocate their spending in the face of rising energy prices. The latest ONS data on card payments suggests that UK households are still “re-allocating rather than reducing”. In other words, inflation and falling real incomes are affecting spending patterns more than overall spending levels, at least so far…
Change (ppt) in card spending by type since 31 December 2021 (Source: ONS; CMMP)
Aggregate spending in the seven days to 1 September 2022 was the same as pre-pandemic levels (see key chart above) and 22ppt higher than at the end of December 2021 (see chart immediately above).
Spending across all categories – delayable, social, staple and work-related goods – has risen YTD most notably, if not unexpectedly, in the case of work-related spending.
Work related spending is currently 38ppt above pre-pandemic levels reflecting the impact of rising fuel prices. In contrast both spending on delayable goods such as clothing and furniture and on socialising remain below pre-pandemic levels.
Trends in work-related spending and spending on delayables in relation to pre-pandemic levels (Source: ONS; CMMP)
Please note that the summary comments and chart above are extracts from more detailed analysis that is available separately.
