Author: cgmallin

“Money and financing the EA economy, 2023”

Reviewing the impact of unprecedented ECB policy tightening

They key chart

Trends in 12-month cumulative flows (EUR bn) presented in a stylised consolidated balance sheet format (Source: ECB; CMMP)

The key message

CMMP Analysis focuses on the implications of the relationship between the money sector and the real economy for macro policy, strategy, investment decisions and asset allocation. Monetary aggregates provide key insights into this relationship and their dynamics help us to understand the impact of monetary policy on money and the financing of the economy.

This post reviews the impact of unprecedented policy tightening by the ECB on money and financing for the euro area (EA) in 2023: what happened; why it happened; and why it matters.

Money flows fell sharply on a 12-month cumulative basis to only €18bn in 2023, down from €590bn in 2022 and €1,009bn in 2021. This dramatic contraction reflects three key factors – the rising opportunity costs of money, portfolio rebalancing and a collapse in bank lending:

  1. Policy tightening increased the opportunity cost of holding money and triggered a re-allocation of overnight deposits to better-remunerated, other ST deposits. Outflows from narrow money or M1 (currency plus overnight deposits) reached €-965bn, from inflows of €23bn in 2022 and €1,018bn in 2021. Inflows to other ST deposits (M2-M1) reached €824bn, from €484bn in 2022 and outflows of €55bn in 2021. Inflows into “marketable instruments” (M3-M”) rose to €158bn in 2023, from €83bn in 2022 and €46bn in 2021.
  2. The phasing out of net asset purchases and TLTROs incentivised bank bond issuance and encouraged portfolio rebalancing away from deposits to LT bank liabilities. Flows into LT liabilities rose to €345bn in 2023, from €38bn in 2022. Note that the latter do not form part of monetary aggregates, by definition.
  3. Bank lending, the principal source of money creation (deposits) collapsed. Cumulative flows of lending to the private sector fell to only €40bn in 2023 (within total credit of €72bn in table above), from €624bn in 2022 and €476bn in 2021.

The contraction in narrow money during 2023, while dramatic, was neither an indicator of liquidity problems for EA banks nor a reliable indicator of economic activity or future inflation. At least not in itself. It was, instead, an example of how policy “normalisation” leads to re-adjustments in the structure and dynamics of bank balance sheets.

The collapse in financing flows to the private sector was far more serious. The pace of change of policy, policy transmission, and policy response is unprecedented and leaves the ECB and EA households and corporates without a playbook.

Dramatically reduced financing flows, historically high policy rates and increased borrowing costs are an unsustainable combination that suggest that the risk of policy errors remains very high at the start of 2024.

Money and financing the EA economy, 2023

CMMP Analysis considers the impact of the ECB’s unprecedented monetary policy on money and financing of the euro area (EA) economy from the perspective of monetary dynamics.

Recall that monetary aggregates are derived from the liabilities side of the consolidated balance sheet of monetary financial institutions (MFIs). Money is then classified according to its liquidity or degree of “moneyness” e.g. narrow money (M1, the most liquid), intermediate money (M2), and then broad money (M3), in the case of the euro area

The calculation of money supply involves adding these components together – in essence, the sum of currency in circulation plus the outstanding amount of financial instruments that have a high degree of moneyness. The simplest way to think about money, therefore, is as the short-term liabilities of the banking sector (note that longer-term liabilities are excluded from the definition of broad money as they considered portfolio instruments rather than as a means of transacting)

M3 = M1 (currency plus overnight deposits) plus M2-M1 (other ST deposits) plus M3-M2 (marketable instruments)

Money can also be calculated and understood by re-arranging the so-called “counterparts of money”, i.e. all items other than money on both sides of the consolidated balance sheet. Hence M3 in the euro area can also be calculated as:

M3 = credit to EA residents + net external assets – longer term liabilities + other counterparts

What happened in 2023 and why?

The collapse in money flows (EUR bn, 12m cumulative) to the euro area (Source: ECB; CMMP)

Money flows fell sharply on a 12-month cumulative basis to only €18bn in 2023, down from €590bn in 2022 and €1009bn in 2021 (see chart above). This dramatic contraction reflects three key factors – the rising opportunity costs of money, portfolio rebalancing and a collapse in bank lending.

The collapse in money flows (EUR bn, 12m cumulative) from a components perspective (Source: ECB; CMMP)

Policy tightening increased the opportunity cost of holding money and triggered a re-allocation of overnight deposits to better-remunerated, other ST deposits. Outflows from narrow money or M1 (currency plus overnight deposits) reached €-965bn, from inflows of €23bn in 2022 and €1018bn in 2021 (the blue columns above). Inflows to other ST deposits (M2-M1) reached €824bn, from €484bn in 2022 and outflows of €55bn in 2021 (the maroon columns above). Inflows into “marketable instruments” (M3-M”) rose to €158bn in 2023, from €83bn in 2022 and €46bn in 2021 (the green columns above).

Portfolio rebalancing and flows to LT liabilities (EUR bn, 12m cumulative) (Source: ECB; CMMP)

The phasing out of net asset purchases and TLTROs incentivised bank bond issuance and encouraged portfolio rebalancing away from deposits to LT bank liabilities (see chart above). Flows into LT liabilities rose to €345bn in 2023, from €38bn in 2022. Note that the latter do not form part of monetary aggregates, by definition.

The collapse in PS financing flows (EUR bn, 12m cumulative) to the euro area (Source: ECB; CMMP)

Bank lending, the principal source of money creation (deposits) collapsed. Cumulative flows of lending to the private sector fell to only €40bn in 2023 (within total credit of €72bn in table above), from €624bn in 2022 and €476bn in 2021 (see chart above).

Why these trends matter

The contraction in narrow money during 2023, while dramatic, was neither an indicator of liquidity problems for EA banks nor a reliable indicator of economic activity or future inflation. At least not in itself. It was, instead, an example of how policy “normalisation” leads to re-adjustments in the structure and dynamics of bank balance sheets.

The collapse in financing flows to the private sector was far more serious. The pace of change of policy, policy transmission, and policy response is unprecedented and leaves the ECB and EA households and corporates without a playbook.

Dramatically reduced financing flows, historically high policy rates and increased borrowing costs are an unsustainable combination that suggest that the risk of policy errors remains very high at the start of 2024.

Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.

“UK corporates and house buyers are reading the BoE’s script…”

…even if consumers are not!

The key chart

Trends in cumulative HH and NFC financing flows (12-months, £bn) (Source: BoE; CMMP)

The key message

UK corporates and house buyers are reading the BoE’s script, even if consumers are not.

Cumulative 12-month financing flows to the household (HH) and corporate (NFC) sectors slowed to £8.3bn in November 2023, down from £65.2bn a year earlier (see key chart above).

  • Cumulative 12-month financing flows to the NFC sector have been consistently negative since January 2023
  • In November 2023, they were -£3.2bn compared with £3.2bn a year earlier i.e. corporates repaid debt throughout 2023
  • Note that the average cost of new NFC borrowing has risen by 495bp to 7.0% since the BoE began policy tightening (see chart below).

Trends in the average cost of new mortgages and NFC loans (%) (Source: BoE; CMMP)

  • Cumulative 12-month finance flows to the HH sector fell to £11.5bn in November, down from £61.3bn a year earlier
  • Lending for house purchases (mortgages) was net zero in November
  • The YoY growth rate for net mortgage lending was 0.3%, the lowest growth rate since the BoE’s monthly data series began back in March 1994
  • Note that the average cost of new mortgages has risen 384bp to 5.34% since the start of policy tightening (see chart above).

So what?

Financing flows to the UK private sector are falling sharply and reaching potential choke points for growth and much needed investment.

Beyond the headlines, there is a sharp contrast in terms of the dynamics of borrowing for consumption (resilient), investment (weak), and house purchases (slowing sharply).

While the message from the UK money sector remains relatively positive for on-going consumer demand, it is far more concerning with respect to investment and real estate.

Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.

“UK consumers are still not reading the BOE’s script”

Monthly consumer credit flows jumped to £2bn in November 2023

The key chart

Monthly flows (£bn) of UK consumer credit since November 2019 (Source: BoE; CMMP)

The key message

UK consumers are still not reading the BoE’s script – at least not fully.

Monthly flows of consumer credit rose to £2.0bn in November 2023 from £1.4bn in October 2023 and £1.5bn in September 2023 (see key chart above). The rise was largely attributable to a £0.5bn increase in borrowing on credit cards from £0.5bn in October 2023 to £1.0bn in November 2023.

The annual growth rate in the stock of consumer credit rose to 8.6% YoY, the highest rate since September 2018.

So what?

The BoE argues that, “higher interest rates make it more expensive for people to borrow money and encourages them to save.” The cost of borrowing has increased and households are saving more too. However, they also continue to borrow to fund consumption – in November the amount was 1.7x the average pre-pandemic flow.

In short, the BoE’s policy appears to resemble a three-legged stool that is missing an important leg…

Please note that the summary comments and chart above are abstracts of more detailed analysis that is available separately.

“What next for US consumption?”

Mixed messages from the US money sector at the end of 2023

The key chart

Long term trends in US consumer credit ($bn) (Source: FRED; CMMP)

The key message

The US money sector sent mixed messages about the outlook for consumption and growth at the end of 2023.

The outstanding stock of consumer credit recorded a new “round number” of $5tr in November 2023, albeit it with a (nominal) rate of growth below its long term trend (see key chart).

Monthly flows ($bn) in US consumer credit (Source: FRED; CMMP)

CMMP Analysis has been following the recent slowdown in monthly flows of consumer credit with interest.

November 2023 saw a reversal of this trend, however. The monthly flow of consumer credit jumped to $24bn, from $6bn in October 2023 and $11bn in September 2023. November’s monthly flow also exceeded the pre-pandemic average flow of $15bn for the first time since May 2023 (see chart above).

The 3m MVA of monthly flows rose to $13bn in November 2023 from under $1bn in October 2023 but remained below its pre-pandemic average of $15bn.

So what?

It is dangerous to read too much into one month’s data release but for now, at least, the message from the money sector is that the “cracking US consumer” narrative is currently on hold….

Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.

“The danger of confusing Canadians and Americans”

Why are Canadian commentators typically more bearish on the outlook for US households?

The key chart

Diverging trends in US and Canadian HH debt service ratios and affordability risks (Source: BIS; CMMP)

The key message

My Canadian friends typically recoil when being mistaken for Americans – and understandably so. They have their own unique nationality, heritage and culture. Despite being close geographical neighbours, they have their own unique experiences too. At the same time, my American friends may recoil when Canadian economic and market commentators allow their own domestic experiences to distort their outlook for US household sector vulnerabilities. Again, understandably so – they each have their own unique experiences.

Confusing Canadians and Americans is rarely a good idea…

For the rest of us the message is clear. Among developed economies, affordability risks are at their highest in Canada, Switzerland, Sweden and France (Lesson #2 from the money sector in 2023). Ignoring key structural shifts in US HH dynamics is a mistake as those who underestimated the resilience of the US consumer found out to their cost last year.

The dangers of confusing Canadians and Americans

Twenty year trends in US and Canadian HH debt ratios (Source: BIS; CMMP)

Note that the US household (HH) debt ratio peaked at 99% GDP back in December 2007 (see chart above). It is now 74% GDP, below the 85% GDP threshold level above which the BIS considers debt to be a constraint on future growth. The Canadian HH debt ratio only peaked 13 years later at 113% GDP in December 2020. It is now 103% GDP, still well above the BIS threshold level.

Twenty year trends in US and Canadian HH RGFs (Source: BIS; CMMP)

The rate of “excess credit growth” (or relative growth factor) – where the 3Y CAGR in debt is above the 3Y CAGR in nominal GDP – peaked in the US at 6.6ppt back in March 2004. In Canada, the rate of excess credit growth did not peak until December 2009 at 7.7ppt. There is one similarity here, however. In both economies, the relative growth factors are currently negative (see chart above).

Diverging trends in US and Canadian HH debt service ratios and affordability risks (Source: BIS; CMMP)

This matters because HH sector vulnerabilities with respect to “affordability risks” are very different in these economies. The HH debt service ratio (DSR) in the US is currently 7.7%. This is 3.9ppt below its historic high of 11.6% and 1.5ppt below its long-term average of 9.2%. In sharp contrast, the HH DSR in Canada is at a record high of 14.4%, 2.1ppt above its long-term average of 12.3%.

Conclusion

Confusing Canadians and Americans is rarely a good idea…

Among developed economies, affordability risks are at their highest in Canada, Switzerland, Sweden and France (Lesson #2 from the money sector in 2023). Ignoring key structural shifts in US HH dynamics is a mistake as those who underestimated the resilience of the US consumer found out to their cost last year.

Happy New Year!

Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.

“Seven lessons from the money sector in 2023”

What have the “messages from the money sector” taught us in 2023?

The key chart

Visual summary of the CMMP Analysis framework linking all economic sectors together (Source: CMMP)

The key message

The key message from CMMP Analysis is that the true value in analysing developments in global finance lies less in considering investments in banks’ equity and more in understanding the implications of the relationship between the money sector and the wider economy for macro policy, corporate strategy, investment decisions and asset allocation.

The 2023 “messages from the money sector” included the importance of post-GFC debt dynamics, the risks of policy errors, the failure of banks to support productive economic activities, and the increasing abuse of macro statistics.

The seven key lessons were:

  1. The risk of a Chinese balance sheet recession dominated 2023 and will DOMINATE 2024 too
  2. “US bears” ignored structural shifts in US debt dynamics post-GFC and underestimated the RESILIENCE OF THE CONSUMER as a result
  3. Aggregate demand in credit-driven economies is equal to income (GDP) PLUS THE CHANGE IN DEBT. Policy makers continue to ignore this truism at OUR peril
  4. The ECB’s policy celebrations may prove PREMATURE
  5. UK policy making is still based on UNBELIEVABLE forecasts and FLAWED macro thinking
  6. Banks are failing to support PRODUCTIVE ACTIVITY and the SME sector in particular
  7. The ABUSE of macro statistics is rife – beware of “panic charts” and their accompanying narratives

Seven lessons from the money sector in 2023

The importance of post-GFC debt dynamics

Lesson #1: the risk of a Chinese balance sheet recession dominated 2023 and will dominate 2024 too

January 2023: Trends in Japanese, Spanish and Chinese private sector debt ratios (% GDP) (Source: BIS; CMMP)

CMMP Analysis began 2023 by questioning the popular, “China-opening story“. We highlighted three structural risks to this narrative – (1) the level of private sector debt, (2) the rate of growth of household debt, and (3) the affordability of private sector debt. We asked two questions.

First, what happens if rather than seeking to maximise profit/utility as traditional economics assumes, the Chinese private sector turns to minimising debt or maximising savings instead?

Second, and following on from this, what if China experiences a balance sheet recession instead?

December 2023: Trends in “excess credit growth” in China since June 2013 (Source: BIS; CMMP)

The balance sheet narrative remained on hold during 2023, but risks remain as we enter 2024. All sectors of the Chinese economy are increasing leverage still. The Chinese government is the main driver here, rather than the private sector, however. Crucially, the dynamics of Chinese money creation and potential growth are shifting. Credit agencies may (mistakenly) wish for lower levels of government debt in China, but given current debt dynamics it will be fiscal policy/government spending that will have to do the heavy lifting in 2024 if China’s growth is to recover.

Lesson #2: “US bears” ignored structural shifts in US debt dynamics post-GFC and underestimated the resilience of the consumer as a result

January 2023: Trends in the stock of US consumer credit ($tr) and the consumer credit to DPI ratio (%) (Source: FRED; CMMP)

CMMP Analysis also began 2023 by questioning the equally popular, “US consumer slowdown narrative”. We argued that “US bears” were ignoring the key structural shifts in US debt dynamics that saw the US leading the advanced world in the structural shift away from high-risk HH debt towards relatively low risk public debt in the post-GFC period. In September 2023, we noted greater affordability risks in other developed economies such as Canada, Switzerland, Sweden, France and Finland and in emerging markets such as Brazil, China and Korea instead.

December 2023: Trends in monthly flows of US consumer credit (Source: FRED; CMMP)

That said, we also noted signs that the US consumer was starting to crack as the year progressed. Quarterly consumer credit flows in the 3Q23 ($4bn) were the weakest since 2Q20, and only a very small fraction of the pre-pandemic average quarterly flow of $45bn. Monthly flow data for October 2023, also suggested that momentum weakened further at the start of 4Q23.

Note the key differences between China and the US here – China’s challenges are more structural in nature, while the US’s challenges are more cyclical.

The risks of policy errors

Lesson #3: Aggregate demand in credit-driven economies is equal to income (GDP) PLUS THE CHANGE IN DEBT. Policy makers continue to ignore this truism at OUR peril.

In September 2023, CMMP Analysis argued that central bank decision making that appears largely “data independent” in relation to private sector credit dynamics is unlikely to produce positive economic outcomes. Instead, it increases the likelihood of policy errors, especially in credit-driven economies.

September 2023: Trends in the UK PS debt ratio (RHS) and PSC relative growth factor (LHS) (Source: BIS; CMMP)

The fundamental error is to ignore that aggregate demand in a credit-driven economy is equal to income (GDP) PLUS THE CHANGE IN DEBT. The addition of the change in debt means that, in reality, aggregate demand is far more volatile than it would be if income alone was its source (as typically assumed). This is especially true for highly indebted economies.

If Schumpeter could understand this in 1934, why can’t policy makers understand it in 2024?

Lesson #4: The ECB’s celebrations may prove to be premature

ECB officials spent much of 2023 arguing that the transmission of monetary policy was working. The tone became almost celebratory by the end of the year, with Board members arguing that not only was the transmission working but also that it was delivering results that were EXACTLY what the ECB wanted to see.

December 2023: Trends in PS financing flows (EUR bn, 12m cum flows) and nominal NFC and HH borrowing costs (%, RHS) (Source: ECB; CMMP)

The risks that these celebrations may prove to be premature are obvious, however, or at least they should be. While monetary policy transmission in the euro area is working as textbooks suggest, both the pace and scale of current tightening is unprecedented. The ECB lacks a playbook for such a scenario and EA economies now find themselves in uncharted territory. Policy tightening continued even as the EA money sector was indicating increases stresses for banks, households and corporates. The end result – a combination of NEGATIVE financing flows to the private sector, historically high policy rates and elevated costs of borrowing – is unlikely to be sustainable in 2024.

Lesson #5: UK policy making is based on unbelievable forecasts and flawed macro thinking

November 2023: Historic and forecast trends in sectoral balances for the UK private and public sectors and the RoW expressed as % GDP (Source: OBR; CMMP)

Official OBR forecasts for the UK economy remain unbelievable when viewed through CMMP Analysis’ preferred sector balances perspective. The March 2023 version suggested a return to the pre-pandemic world of economic imbalances and an economy forecast to remain heavily dependent on net borrowing from abroad – the irony of post-Brexit Britain. The November 2023 version presented a more balanced outlook and a more realistic forecast for private sector dynamics but was simply too dull to be true.

December 2023: Trends in UK PS debt ratio (% GDP, RHS) and relative growth versus nominal GDP (3Y CAGR %, LHS) (Source: BIS; CMMP)

The UK private sector debt ratio fell back to its March 2022 level at the end of 2Q23. This matters because neither Jeremy Hunt (the current UK Chancellor) nor Rachel Reeves (his likely successor) appear to recognise the folly of combining austerity with private sector deleveraging (“pre-COVID Britain”). The next general election will be fought on the wrong macro battleground as a result. Both parties will repeat the flawed narrative that governments (that enjoy monetary sovereignty) face the same financial constraints as households and that public debt is a problem while largely ignoring private debt. A depressing thought for the year ahead.

The failure of banks

Lesson #6: Banks are failing to support productive activity and the SME sector in particular

February 2023: Trends and breakdown of UK FIRE-based (red and pink) and COCO-bases (blue) lending (£bn) (Source: BoE; CMMP)

A more appropriate macro policy debate in the run-up to the next election would focus on the role of banks. UK banking, for example, is heavily geared towards less-productive FIRE-based lending that supports capital gains rather than productive COCO-based lending that supports investment, production and income formation.

October 2023: Trend in the outstanding stock of SME loans since 2013 (£bn) (Source: BoE; CMMP)

UK banking also fails SMEs, the lifeblood of the UK economy. Only 22 pence in every pound lent in the UK is for productive purposes and only c.7pence is lent to SMEs. This is despite the fact that SMEs account for 50% of private sector turnover and 60% of employment. SMEs cannot invest fully in growth, job creation, innovation and equality if and when: (1) their access to external capital is constrained by LT structural factors; (2) flows of financing (both loans and overdrafts) are negative; and (3) their cost of borrowing is rising so rapidly.

The abuse of macro statistics

Lesson #7: The abuse of macro statistics is rife – beware of “panic charts” and their accompanying narratives.

CMMP Analysis suggests that US public sector debt and trends in narrow money (M1) are the most widely abused macro statistics of the year.

May 2023: 50 years of US public sector debt dynamics – plotted differently! (Source: FRED; CMMP)

The abuse of US public sector debt data involves five elements. First, ignoring the fact that public debt is both a liability for the government sector and an asset of the non-government sector. Second, making no comparison with GDP. Third, ignoring inflation. Fourth, presenting long time series data using linear scales. Fifth and finally, ignoring private sector debt dynamics completely (see also lesson #2 above).

November 2023: Growth trends (% YoY) in narrow money (M1) and other short term deposits (M2-M1) (Source: ECB; CMMP)

The abuse of monetary aggregate statistics is more understandable given that growth in narrow money is falling rapidly, and that real growth rates in M1 typically display leading indicator properties with real GDP. This means that M1 dynamics make great headlines for sure, but they only tell one part of the macro and banking stories. The rising opportunity cost of holding money, on-going portfolio rebalancing and the mechanics of money creation are important too. Policy normalisation leads to natural re-adjustments in the structure of MFI consolidated balance sheets. This can and does create dramatic movements in individual items and monetary variables such as M1 and increases the risk of misinterpretation.

In short, monetary aggregates still matter. To return to the key message from CMMP Analysis, they tell us a great deal about the interaction of the banking sector and the wider economy, but they need interpreting with due care and attention…

Thank you for reading and very best wishes for a very happy and healthy new year.

Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.

“Shout it out loudly!”

The UK private sector debt ratio is back to March 2002 levels

The key chart

Trends in UK private sector debt ratio (% GDP, RHS) and relative growth versus nominal GDP (3Y CAGR %, LHS) (Source: BIS; CMMP)

The key message

Don’t whisper it softly this time – shout it out loudly instead:

…the UK private sector debt ratio is back to March 2002 levels

This matters because neither Jeremy Hunt (the current UK Chancellor) nor Rachel Reeves (his likely successor) appear to recognise the folly of combining austerity with private sector deleveraging (“pre-COVID Britain”). The next election will be fought on the wrong macro battleground as a result.

According to the latest BIS data release, the UK private sector’s debt ratio was 147% GDP at the end of 2Q23, down from its all-time high of 186% GDP in 1Q10 and its recent high of 177% GDP in 1Q21 (see key chart above).

The corporate sector debt ratio has fallen from 90% GDP in 4Q08 to 66% GDP in 2Q23, while the household sector debt ratio has fallen from 98% GDP in 4Q09 to 81% in 2Q23. The UK now joins the US, Germany and Italy among the small group of advanced nations where both sector’s debt ratios are below the BIS threshold limits, above which debt is considered a drag on future growth.

Note that the private sector’s share of total UK debt has fallen from almost 80% at the time of the GFC to 62% now. In short, the UK has followed the US in substituting higher-risk household debt with lower risk government debt since the GFC.

As the UK approaches a general election next year, the macro policy debate should be around:

UK banking is geared currently towards less-productive FIRE-based lending that supports capital gains rather than productive COCO-based lending that supports investment, production and income formation. UK banking also fails SMEs – the lifeblood of the UK economy. Only 22 pence in every pound lent in the UK is for productive purposes and only 7 pence is lent to SMEs. This is despite the fact that SMEs account for 50% of private sector turnover and 60% of employment.

Equally troubling, the UK policy debate focuses on reducing the level of government borrowing further based on the flawed narrative that governments face the same financial constraints as households and equally flawed macro thinking that sees public debt as a problem while largely ignoring private debt. The irony for “post-Brexit” Britain is that this leaves us increasingly dependent on financial flows from the RoW. A depressing thought at the end of the year.

Time for shouting not whispering…

Please note that summary comments and chart above are abstracts from more detailed analysis that is available separately.

“Whisper it softly – Part IV”

The “emerging market” classification has been redundant for some time now

The key chart

Trends in market share (%) of global debt since June 2009 (Source: BIS; CMMP)

The key message

Whisper it softly; the “emerging market” (EM) classification has been redundant for some time now.

CMMP analysis has questioned the relevance and usefulness of the “emerging market” classification for some time. The latest BIS data release, merely supports this view, at least from a debt perspective.

EM’s share of global debt has increased from 18% in June 2009 (at the time of the GFC) to 40% in June 2023 – a remarkable structural shift (see key chart above).

Over this period the EM debt ratio has risen from 97% GDP to 156% GDP, and is now only 6ppt below the debt ratio of so-called “advanced” of “developed markets” (DM).

For reference, the DM debt ratio has fallen from 174% GDP at the beginning of this period and from its all-time high of 183% GDP in 4Q20.

These dynamics have supported a popular investment narrative called, “The EM-debt story”.

In my previous post, however, I noted that all sectors of the Chinese economy are increasing their levels of indebtedness and that all their debt ratios hit new highs in 2Q23 (see “Whisper it softly – Part III“).

The key point here is that if we strip out China, EM’s shares of global debt has only increased slightly since the GFC, from 10% to 13%.

What this means is that rather than witnessing an EM-debt story, we have, in fact, been witnessing “The China-debt story” since the GFC.

So what?

While the EM classification remains convenient, it is increasingly less relevant and/or helpful in terms of understanding the impact of global debt dynamics on macro policy, investment decisions and financial stability.

Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.

“Whisper it softly – Part III”

All sectors of the Chinese economy are increasing leverage still, but…

The key chart

Trends in “excess credit growth” in China since June 2013 (Source: BIS; CMMP)

The key message

Whisper it softly (III), but all sectors of the Chinese economy are increasing their levels of indebtedness still.

The Chinese government is the main driver here, rather than the private sector, however. The rate of private sector “excess credit” generation has slowed markedly (see key chart above). With a (private sector) balance sheet recession still a risk (if not a reality yet), these trends can be expected to continue.

According to the latest BIS date release, China’s total, government, household (HH), corporate (NFC) and private sector (PS) debt ratios all hit new highs in 2Q23 (308%, 79%, 62%, 166% and 228% GDP respectively). China now accounts for 23% of total global debt, 26% of global PS debt and 32% of global NFC debt. In June 2009, these shares were only 7%, 8% and 12% respectively.

A key dynamic to note here, however, is the rate of growth in debt or “excess credit” generation. At times, this can be as important, if not more important than the level of debt/indebtedness. The key chart above illustrates the 3Y CAGR in government, HH and NFC debt in relation to the 3Y CAGR in nominal GDP.

Three distinct phases are visible – the first (1) includes the period of excess HH, NFC and government credit growth; the second (2) includes the period of excess HH and government debt, and the third (3 and current phase) includes excess government credit growth but much slower rates of HH and NFC excess credit growth.

At the start of 2023, I posed the question, “what if China’s private sector turns to debt minimisation/savings maximisation instead?” Or, “what if China experiences as balance sheet recession?”

As noted later in September 2023, the “balance sheet recession” story is still on hold, at least for the time being. Although it did become part of the 1H23 investment narrative briefly. Nonetheless, the dynamics of money creation and potential growth are shifting clearly. Credit rating agencies may (mistakenly) wish to see lower levels of government debt in China, but if current dynamics continue it will be fiscal policy/government spending that will have to do the “heavy lifting” if China’s growth is to recover.

Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.

“Whisper it softly – Part II”

US private sector indebtedness is largely unchanged over the past two decades

The key chart

Trends in US private sector debt ratio (% GDP, RHS) and relative growth versus nominal GDP (3Y CAGR %, LHS) (Source: BIS; CMMP)

The key message

Whisper it softly, but the level of US private sector INDEBTEDNESS is largely unchanged over the past TWO DECADES.

According to the latest BIS data release, the private sector debt ratio was 150% GDP at the end of 2Q23, down from its all-time peak of 170% GDP (3Q08) and its recent “pandemic-peak” of 162% GDP (4Q20). For reference, the debt ratio was 149% GDP at the end of 2Q03 (see key chart above).

The absolute level of debt reached a new high ($39.9tr) in 2Q23, however, re-enforcing the difference between the level of debt and the level of indebtedness. A key distinction that is often overlooked in popular, but flawed, US debt narratives.

Over the past three years, private sector debt has grown at a CAGR of 5.6%. Nominal GDP has grown at a CAGR of 7.6% over the same period. This negative “relative growth factor” is illustrated when the blue shaded area in the key chart above falls below the x-axis.

Note that over the past two decades, private sector debt has fallen from 73% of total US debt to 60% of total US debt. Lower-risk, government debt substituted for higher-risk household debt as the private sector embarked on a period of passive deleveraging post-GFC. The US led the advanced world in this important development.

The household debt ratio has fallen from its 1Q08 peak of 98% GDP to 74% GDP at the end of 2Q23. The corporate sector debt ratio has fallen from its 1Q21 peak of 84% GDP to 77% GDP at the end of 2Q23.

So what?

The US is one of only three advanced economies that has both household and corporate debt ratios BELOW the BIS threshold limits above which debt becomes a constraint on future growth. How often is this part of US debt narratives?

Viewed in this context, and recognising the distinction between the level of debt and the level of indebtedness, the resilience of US consumption and growth in the face of unprecedented monetary tightening becomes less surprising…

Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.