Trends in global house prices since the GFC (Source: BIS; CMMP)
The key message
Anyone looking for evidence of COVID-19 “herd immunity” need look no further than global housing markets!
House prices rose 4% globally in 2020 in real terms, the fastest rate of growth since the GFC. Prices rose 7% in advanced economies, compared with a more modest 2% in emerging economies. House price resilience during the pandemic reflects many factors: a recovery in HH incomes thanks to continued policy support; lower borrowing costs; reduced supply as construction activity slowed; temporary tax breaks; and perceptions that housing was/is a relatively safe investment.
The combination of rising prices and an uncertain macro backdrop has kept measures of overvaluation elevated. In the euro area, for example, above average increases in house prices occurred in Luxembourg, Slovakia, Estonia, Portugal, Denmark, Austria, the Netherlands and France. With the exception of Estonia, estimates suggested overvaluation in each of these countries before the start of 2020, notably in Luxembourg, Denmark and Austria. Similarly, the Bank of England indicated unease about the UK housing market recently (1 June 2021) after the Nationwide Building Society said that prices were growing at their fastest pace since 2014.
Current EA housing and lending dynamics reflect Minsky’s hypothesis that, over the course of a long financial cycle, there will be a shift towards riskier and more speculative sectors. The flow of funds towards property and financial asset markets (FIRE-based lending) is increasing at the expense of more productive flows to the real economy (COCO-based lending). FIRE-based lending in the EA hit a new high of €5,905bn in April 2021 and accounts for 52% of total lending with negative implications for leverage, growth, stability and income inequality.
Resilience and risks in global housing
Anyone looking for evidence of COVID-19 “herd immunity” need look no further than global housing markets! House prices rose 4% globally in 2020 (in real terms) according to latest BIS data release, the fastest rate of growth since the GFC. Prices are now 21% higher than their average after the GFC (see chart below).
Real price change in 2020 plotted against real price change since the GFC (Source: BIS; CMMP)
Prices rose 7% in “advanced economies” (especially New Zealand, Canada, Denmark, Portugal, Austria, Germany, US) compared with a more modest 2% in “emerging economies.” The resilience of housing markets reflects many factors: a recovery in HH incomes thanks to continued policy support; lower borrowing costs; reduce supply as construction activity slowed; temporary tax breaks; and the perceptions that housing was/is a relatively safe investment.
EA trends – 2020 price change ploted against valuation at end-2019 (Source: ECB; CMMP)
The key risk here is that the combination of rising prices and an uncertain macro backdrop have kept measures of overvaluation elevated.
In their latest Financial Stability Review, for example, the ECB notes that “house price growth during the pandemic has generally been higher for those countries that were already experiencing pronounced overvaluation prior to the pandemic (see chart above).”
The largest/above average increases in house prices during 2020 in the EA occurred in Luxembourg (17%), Slovakia (16%), Estonia (9%), Portugal (9%), Denmark (9%), Austria (7%), the Netherlands (7%) and France (6%). With the exception of Estonia, ECB estimates suggest that house prices were overvalued in each of these countries before the start of 2020, notably in Luxembourg (39% overvalued, not shown in graph above), Denmark (16% overvalued) and Austria (15% overvalued).
On the 7 June 2021, the BIS will release 4Q20 credit and affordability data which will provide further insights into the risks associated with housing trends in the EA and the rest-of-the-world.
The rise in FIRE-based lending in the euro area (Source: ECB; CMMP)
In recent posts, I have noted an adaptation of Hyman Minsky’s hypothesis that states that over the course of a long financial cycle, there will be a shift towards riskier and more speculative sectors.
Minsky’s theory can be applied to the house price trends described above and to HH lending trends described in previous posts. Minsky’s “shift” is reflected in the decline in bank credit to the real sector (COCO-based credit) and an increase in funds flowing towards property and financial asset markets (FIRE-based credit).
FIRE-based lending in the EA hit a new high of €5,905bn in April 2021 and accounts for 52% of total lending with negative implications for leverage, growth, stability and income inequality.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
What do 1Q21 results say about 2021’s investment themes?
The key chart
YoY changes (%) in customer lending and customer accounts by region (Source: HSBC; CMMP)
The key message
As a shareholder, I was relieved to see the 4% bounce in HSBC’s share price today, but as a global investor I was far more interested in what this morning’s 1Q21 results said about wider investment themes.
The results clearly illustrate the desynchronization of global money and credit cycles with customer accounts growing 15% YoY while customer lending was flat. The same trend was seen across all regions on an annual basis and across HSBC’s wealth and personal banking (WPB) and commercial banking (CMB) divisions. Asia bucked the trend over the most recent quarter, however, as customer lending rose 2% QoQ while customer accounts fell marginally, but lending fell QoQ in Europe and the UK.
1Q21 change ($bn) in customer lending and customer accounts by region (Source: HSBC; CMMP)
Credit investors may welcome HSBC’s strong capital position (CET1 15.9%) and abundant liquidity (LDR 63%) but other investors should note the broader message with respect to the so-called “reflation trade”.
1Q20 and 1Q21 loan-deposit ratios by region (Source: HSBC; CMMP)
The top-down and bottom-up messages from the money sector remain the same: (1) money and credit cycles remain out of synch with each other, and (2) money sitting idly in deposit accounts contributes to neither GDP nor inflation.
Total debt levels and cumulative market share as at the end of 3Q20 (Source: BIS; CMMP)
The key message – seven perspectives
First, the US has the highest outstanding stock of debt in the world but deeper analysis is required to determine whether it has a “debt problem”
Second, in terms of debt ratios (debt/GDP), the US ranks outside the world’s highly indebted economies across the government, household (HH) and corporate (NFC) sectors
Third, the US is also one of only four developed market economies to have both HH and NFC debt ratios below the BIS maximum thresholds
Fourth, the current structure of US debt is the mirror image of the pre-GFC structure following the significant shift away from HH to government debt
Fifth, this changing structure reduces associated risks since the government faces different financial constraints to the HH and NFC sectors and cannot, as a currency issuer, become insolvent
Sixth, the risks associated with the level, growth and affordability of HH debt remain moderate in absolute and relative terms
Seventh, risks are elevated in the NFC sector, however, due to the recent rates of excess credit growth and affordability concerns but these risks are not exclusive to the US.
In short, risks associated with US debt are concentrated rather than systemic. Moreelevated risks exist in other developed and emerging economies where some of the highest rates of excess credit growth are occurring in highly indebted economies and affordability risks are rising despite the low interest rate environment. Investor attention should not be restricted to US debt simply due to its size – more immediate concerns lie elsewhere.
Does the US have a debt problem?
Outstanding US debt and market share by sector (Source: BIS; CMMP)
The US has the highest outstanding stock of total, government, HH and NFC debt in the world but deeper analysis is required to determine whether it has a “debt problem”.
The US has outstanding total, government, NFC, and HH debt of $61tr, $27tr, $18tr and $16tr respectively (as at end 3Q20). The US accounts for 29% of global debt alone and almost 50% together with China (see key chart above) and has market shares of 34%, 22% and 32% of global government, NFC and HH debt respectively (see chart above).
To understand the implications here and consider whether the US has a debt problem, CMMP analysis considers the stock of debt in the context of the level of GDP (debt ratios), its structure, its rate of growth and affordability.
Ranking of BIS reporting economies by total debt/GDP (Source: BIS; CMMP)
In terms of debt ratios (debt/GDP), the US ranks outside the world’s highly indebted economies in all sub-sectors. It is ranked only #18 in terms of total debt ratio for example (see chart above), and #22 and #12 in terms of NFC and HH debt ratios. In the case of government debt (129% GDP), the US is ranked higher, however, at #10 after Japan (235%), Greece (212%), Italy (172%), Portugal (146%), Belgium (137%), France (134%), UK (133%) and Spain (132%).
NFC and HH debt ratios plotted against BIS maximum threshold levels (Source: BIS; CMMP)
The US is one of only four developed market economies to have both HH and NFC debt ratios below the BIS maximum thresholds. The BIS considers HH and NFC debt ratios of 85% and 90% GDP to be threshold levels above which debt becomes a constraint on future growth. The BIS provides debt ratios for 22 developed and 21 emerging economies. As can be seen in the scatter diagram above, the US sits in the lower LH quadrant with a HH debt ratio of 78% and a NFC debt ratio of 84%. Germany, Greece and Italy are the only other developed economies to sit within the same quadrant.
Breakdown of outstanding US debt by sector (Source: BIS; CMMP)
The current structure of US debt is the mirror image of the pre-GFC structure following the significant shift away from HH debt to government debt. The share of HH debt peaked at 44% total debt in 2Q07 and fell to 27% by end 3Q20. In contrast, the share of government has risen from 26% to 44% over the same period.
As the Federal Reserve Bank of St Louis noted back in 2018, “The fall in household debt was primarily driven by the fall in mortgage debt that followed the housing crash. The surge in public debt, on the other hand, was partly driven by the large fiscal stimulus packages that were deployed to fight the Great Recession.”
The changing structure of US debt reduces associated risks since the government faces different financial constraints and cannot, as a currency issuer, become insolvent. HHs, NFCs and financial institutions are all “currency users” who 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, the US government, as a currency issuer, cannot become insolvent in its own currency since it can always make payments as they come due in its own currency.
In the seventh lesson from the money sector, I highlighted an article published by David Andolfatto of the Federal Reserve Bank of St Louis (4 December 2020). In line with my preferred financial sector balances approach, Andolfatto questions the “government as a household” analogy and notes that, “to the extent that government debt is held domestically, it constitutes wealth for the private sector.” From here, and more significantly, he argues that:
“…it seems more accurate to view the national debt less as a form of debt and more as a form of money in circulation…The idea of having to pay back money already in circulation makes little sense, in this context. Of course, not having to worry about paying back the national debt does not mean there is nothing to be concerned about. But if the national debt is a form of money, wherein lies the concern?”
“Does the National Debt Matter?” Federal Reserve Bank of St. Louis, December 2020
Trend in HH debt/GDP ratio over past 20 years (Source: BIS; CMMP)
Sixth, the risks associated with the level, growth and affordability of HH debt remain moderate in absolute and relative terms. High levels of household indebtedness were an important contributing factor to the GFC and subsequent recession. The HH debt ratio rose to a peak of 99% GDP in 1Q08 well above the 85% BIS threshold level. This ratio is 78% GDP today. Not only was the level of HH debt a matter of concern, but the pace of growth was sending clear warning signals too.
Rolling 3-year RGF for US HH sector over past 20 years (Source: BIS; CMMP)
CMMP analysis uses a relative growth factor to analyse the rate of growth in debt. This compares the 3-year CAGR of debt with the 3-year CAGR in nominal GDP. As can be seen in the chart above, the RGF for the US HH sector peaked at 7% in 1Q04, fell and then remained negative for 41 consecutive quarters from 2Q10 until the last reporting quarter (3Q20).
HH RGFs plotted against HH debt ratios for advanced BIS economies (Source: BIS; CMMP)
In the context of other developed economies, the risks of excess HH credit growth are much lower in the US than in Norway, Sweden, Canada, Switzerland, New Zealand and the UK. Each of these economies are experiencing excess HH credit growth (ie, RGF > 1) despite relatively high debt ratios that exceed the BIS threshold level of 85% GDP.
DSR (%) and deviation from 10Y average for advanced BIS economies (Source: BIS; CMMP)
In terms of affordability risk, the debt service ratio for the US HH sectors is low in absolute terms (7.6%) and in relative terms against its own 10Y average of 8.3% and against other developed economies.
Trend in NFC debt ratio over past 20 years (Source: BIS; CMMP)
Risks are elevated in the NFC sector, however, due to the recent rates of excess credit growth and affordability concerns but these risks are not exclusive to the US. The NFC sector experienced 33 consecutive quarters of a rising debt ratio since 1Q12 and at 84% GDP is very marginally below the recent peak in 2Q20. Note however, that while the current NFC debt ratio is high in the context of the US, it remains below the 90% BIS threshold.
Rolling 3-year RGF for US NFC sector over past 20 years (Source: BIS; CMMP)
Of more concern is the current 4ppt rate of excess NFC credit growth. As can be seen, the current RGF is close to previous peaks. This is despite fact that the absolute level of NFC debt is higher than at previous peaks in excess growth. The current RGF places the US among a group of seven developed economies experiencing excess NFC credit growth of more than 4ppt. Within this sample, Sweden, France, Canada, Switzerland and Japan are experiencing higher rates of excess growth despite having higher levels of NFC debt that exceed the BIS maximum threshold level of 90%.
NFC RGFs plotted against NFC debt ratios for advanced BIS economies (Source: BIS; CMMP)
Finally, the highest level of concern relates to the affordability of NFC debt. The current NFC debt service ratio of 47% is only marginally below its all-time high and is 8ppt above its 10-year average of 39%. Among developed economies, this places the US NFC sector among the higher risk sectors, albeit it below the NFC sectors in France, Canada and Sweden.
DSR (%) and deviation from 10Y average for advanced BIS economies (Source: BIS; CMMP)
Conclusion
The risks associated with US debt are more concentrated than systemic and relate mainly to the rate of excess NFC credit growth and its affordability.(Further incentive for the Federal Reserve to keep rates lower for longer?) From a global perspective, debt risks are more elevated in other developed and emerging economies. Some of the highest rates of excess credit growth are occurring in highly indebted economies and affordability risks are increasing within and outside this sub-set despite the low interest rate environment.
Investor attention should not be restricted to US debt simply due to its size – more immediate concerns lie eslewhere.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available seperately.
Are the risks associated with excess growth re-emerging? Excess credit growth versus penetration rates (Source: BIS; CMMP)
The key message
Risks associated with “excess credit growth”, which had been declining in the pre-Covid period, have re-emerged during the pandemic.
Some of the highest rates of excess credit growth are currently occurring in economies where debt levels exceed maximum threshold levels (Singapore, France, Hong Kong, South Korea, Japan, Canada).
Affordability risks are also increasing within and outside (Sweden, Switzerland, Norway) this sub-set despite the low interest rate environment.
Risks are more elevated in the corporate (NFC) sector than in the household (HH) sector but are not unique to either the developed market (DM) or emerging market (EM) worlds – one more reason to question the relevance of the current DM v EM distinction
Much of the debate relating to global debt focuses exclusively on the level of debt and, to a lesser extent, on the debt ratio (debt as a percentage of GDP). This analysis highlights how the addition of growth and affordability factors provides a more complete picture of the risks associated with current trends and their investment implications.
Introduction
As noted above, much of the recent debate about global debt has been restricted to its level in absolute terms or as a percentage of GDP. The addition of other factors – the rate of growth in debt, its affordability and, in the case of many EMs, its structure – provides a more complete picture, however.
In this post, I add condsideration of the rate of growth in global debt to my previous analysis in “D…E…B…T, Part II.” The approach is based on the simple relative growth factor (RGF) concept which I have used since the early 1990s as a first step in analysing the sustainability of debt dynamics. I also link both to the affordability of debt as measured by debt service ratios (DSRs).
In short, this approach compares the rate of “excess credit growth” with the level of debt penetration in a given economy. The three-year CAGR in debt is compared with the three-year CAGR in nominal GDP to derive a RGF. This is then compared with the level of debt expressed as a percentage of GDP (the debt ratio).
The concept is simple – one would expect relative high levels of excess credit growth in economies where the level of leverage is relatively low and vice versa. Conversely, red flags are raised when excess credit growth continues in economies that exhibit relatively high levels of leverage or when excess credit growth continues beyond previously observed levels.
The key trends
Rolling private sector RGF for all BIS reporting, developed and emerging economies (Source: BIS; CMMP)
In the pre-COVID period, the risks associated with excess credit growth had been declining in developed (DM) and emerging (EM) economies (see chart above illustrating rolling RGF trends). In response to the pandemic, however, credit demand has risen while nominal GDP has fallen sharply. As a result, the RGF (as at the end of 3Q20) for all economies, DM and EM have risen to 3%, 2% and 4% respectively. As can be seen, these levels are elevated but remain below those seen in previous cycles during the past 15 years.
Private sector credit snapshots
Excess PS credit growth versus PS debt ratios as at end 3Q20 (Source: BIS; CMMP)Top ten ranking of private sector RGF by country (Source: BIS; CMMP)
Importantly, out of the top-ten economies experiencing the highest rates of excess private sector credit, six have private sector debt ratios higher than the threshold levels above which debt is considered a constraint to future growth – Singapore, France, Hong Kong, South Korea, Japan and Canada. In the graph above, and in similar ones below, the orange bar indicates where debt ratios exceed the threshold level.
Excess PS credit growth versus PS debt ratios as at end 3Q20 in LATEMEA (Source: BIS; CMMP)
Argentina and Chile have the highest private sector RGFs among the sample of LATEMEA economies. The associated risks are higher in the case of Chile than in Argentina given the two economies debt ratios of 169% GDP and 24% GDP respectively. As highlighted below, the risks in Chile relate primarily to excess growth in the NFC sector.
DSR and deviations from 10-year averages (Source: BIS; CMMP)
Within this subset, the debt service ratios in absolute terms and in relation to respective 10-year averages are also relatively high in France, Hong Kong, South Korea, Japan and Canada despite the low interest rate environment. Outside this subset, affordability risks are relatively high in Sweden, Switzerland and Norway where DSR’s are relatively high in absolute terms and in relation to each economy’s history.
NFC credit snapshots
Excess NFC credit growth versus NFC debt ratios as at end 3Q20 (Source: BIS; CMMP)Top ten ranking of NFC RGF by country (Source: BIS; CMMP)
Similarly, out of the top-ten economies experiencing the highest rates of excess NFC credit, seven have NFC debt ratios above the threshold level (90% GDP) – Singapore, Chile, France, Canada, Japan, South Korea and Switzerland.
DSR and deviations from 10-year averages (Source: BIS; CMMP)
Within this second subset, the debt service ratios in absolute terms and in relation to respective 10-year averages are relatively high in France, Canada, Japan and South Korea. Despite lower rates of excess NFC credit growth affordability risks are also relatively high in Sweden, Norway and the US. (Note that the availability of sector DSRs is more restricted than overall private sector DSRs).
HH credit snapshots
Excess HH credit growth versus HH debt ratios as at end 3Q20 (Source: BIS; CMMP)Top ten ranking of HH RGF by country (Source: BIS; CMMP)
In contrast, out of the top-ten economies experiencing the highest rates of excess HH credit, only two have HH debt ratios above the threshold level – Hong Kong and Singapore. This is not surprising given that HH debt ratios are lower than NFC debt levels in general. Of the 42 BIS reporting countries, 11 have HH debt ratios above the 85% GDP HH threshold level whereas 20 have NFC debt ratios above the 90% GDP NFC threshold level.
Rolling HH RGFs for China and Russia (Source: BIS; CMMP)
That said, experience suggests that the current levels of excess HH credit growth in China and Russia indicate elevated risks, especially in the former economy. In “Too much, too soon?“, posted in November 2019, I highlighted the PBOC’s concerns over HH-sector debt risks – “the debt risks in the HH sector and some low income HHs in some regions are relatively prominent and should be paid attention to.” (PBOC, Financial Stability Report 2019). Excess credit growth remains a key feature nonetheless.
DSR and deviations from 10-year averages (Source: BIS; CMMP)
Within this third subset, the debt service ratio in absolute terms and in relation to respective 10-year averages is relatively high in South Korea. Again, despite lower rates of excess HH credit growth, affordability risks are also relatively high in Sweden and Norway.
Conclusion
This summary post extends the analysis of the level of global debt and debt ratios to include an assessment of the rate of growth in debt and its affordability. Together, these factors provide a more complete picture of the sustainability of current debt trends.
Risks associated with excess credit growth are re-emerging and will be a feature of the post-COVID environment going forward. The two key risks here are: (1) some of the highest rates of excess credit growth are currently occurring in economies where debt levels exceed threshold levels; and (2) affordability risks are increasing within (and outside) this sub-set despite the low interest rate environment.
To some extent, little of this is new news – I have been flagging the same risks in an Asia context for some time – and the implications are the same. Despite recent market moves, the secular support for rates remaining “lower-for-longer” remains, albeit with more elevated sustainability risks in the NFC sector.
Revisiting the level and structure of global debt six months on
The key chart
What are the implications of new highs in global debt and debt ratios? (Source: BIS; CMMP)
The key message
Global debt hit new highs in absolute terms ($211tr) and as a percentage of GDP (277%) at the end of 3Q20, driven largely by government ($79tr) and NFC debt ($81tr).
Public sector and NFC debt ratios both hit new highs above the maximum threshold level that the BIS considers detrimental to future growth.
These trends provide on-going support for the “lower-for-longer” narrative but also raise concerns about sustainability risks in the NFC sector.
The US and China account for nearly 50% of global debt alone and more than 75% with Japan, France, the UK, Germany, Canada and Italy – but only Japan and France are included in the top-ten most indebted global economies.
The post-GFC period of private sector deleveraging/debt stability in advanced economies has ended as the private sector debt ratio increased to 179% GDP.
China’s accumulation of debt has eclipsed the “EM catch-up story”. Chinese debt now accounts for just under 70% of EM debt and EM x China’s share of global debt has remained unchanged over the past decade.
The traditional distinction between advanced/developed markets and emerging markets is increasingly irrelevant/unhelpful, especially when analysing Asian debt dynamics.
New terms of reference are required for analysing global debt trends that distinguish between economies with excess HH and/or corporate debt and the rest of the world. From this more appropriate foundation, further analysis can be made of the growth and affordability of debt…
D…E…B…T, Part II
Breakdown of global debt and trend in debt ratio since 2008 (Source: BIS; CMMP)
Global debt hit new highs in absolute terms and as a percentage of GDP at the end of 3Q20, driven largely by public sector debt and NFC debt. According to the BIS, total debt rose from $193tr at the end of 1Q20 to a new high of $211tr. Within this:
Government, NFC and HH debt all hit new absolute highs of $79tr, $81tr and $51tr respectively
The global debt ratio increased from 246% GDP in 1Q20 to a new high of 278% GDP
The public sector debt ratio increased from 88% GDP to 104% GDP and the NFC debt ratio increased from 96% GDP to 107% GDP over the same period. In both cases, the debt ratio was a new high and above the maximum threshold level of 90% above which the BIS considers the level of debt to become a constraint on future growth
The HH debt ratio also increased from 61% GDP to 67% but remains below its historic peak of 69% (3Q09) and the respective BIS threshold level of 85% GDP.
These trends provide on-going support for the “lower-for-longer” narrative but also raise concerns about sustainability especially in the NFC sector.
3Q20 ranking of BIS reporting economies by total debt and cumulative market share (Source: BIS; CMMP)
The US and China account for nearly 50% of global debt, but neither is ranked in the top-15 most indebted economies. At the end of 3Q20, total debt reached $61tr (29% global debt) in the US and $42tr in China (20% global debt). In absolute terms, these two economies are followed by Japan $21tr, France $10tr, UK $8tr, Germany $8tr, Canada $6tr and Italy $tr. In other words, the US and China account for almost a half of global debt and together with the other six economies account for over three-quarters of global debt. Note, however, that only two of these eight economies rank among the top-ten most indebted global economies (% GDP).
3Q20 ranking of BIS reporting economies by total debt as % GDP (Source: BIS; CMMP)
The post-GFC period of private sector deleveraging/debt stability in advanced economies has ended as the private sector debt ratio rose to 179% GDP, close to its all-time-high. Following the GFC, the private sector debt ratio in advanced economies had fallen from a peak of 181% GDP in 3Q09 to 151% in 1Q15. It had then stabilised at around the 160% of GDP level.
Private sector debt in advanced economies in absolute terms and as % GDP (Source: BIS; CMMP)
As discussed in “Are we there yet?”, this had direct implications for the duration and amplitude of money, credit and business cycles, inflation, policy options and the level of global interest rates. In subsequent posts, I will examine the implications of these recent trends on the sustainability and affordability of private sector debt in advanced economies.
Trends in China’s private sector debt and share of EM private sector debt (Source: BIS; CMMP)
China’s accumulation of debt has eclipsed the “EM catch-up story”. Fifteen years ago, China’s debt was just under $3tr and accounted for 35% of total EM debt. At the end of 3Q20, China’s debt had increased to $33tr to account for 67% of total EM debt. The so-called EM catch-up story is in effect, the story of China’s debt accumulation. Excluding China, EM’s share of global debt in unchanged (12%) over the past decade.
China and EMx China’s share of global debt (Source: BIS; CMMP)
The traditional distinction between advanced/developed markets and emerging markets is increasingly irrelevant/unhelpful, especially when analysing Asian debt dynamics. The BIS classifies Asian reporting countries into two categories: three “advanced” economies (Japan, Australia and NZ) and eight emerging economies (China, Hong Kong, India, Indonesia, Korea, Malaysia, Singapore and Thailand).
Asian NFC and HH debt ratios (Source: BIS; CMMP)
The classification of Japan, Australia and New Zealand as advanced economies is logical but masks different exposures to NFC (Japan) and HH (Australian and New Zealand) debt dynamics.
The remaining grouping is more troublesome as it ignores the wide variations in market structure, growth opportunities, risks and secular challenges. I prefer to consider China, Korea, Hong Kong and Singapore as unique markets. China is unique in terms of the level, structure and drivers of debt and in terms of the PBOC’s policy responses. Korea and Hong Kong stand out for having NFC and HH debt ratios that exceed BIS maximum thresholds. Hong Kong and Singapore are distinguished by their roles as regional financial centres but have different HH debt dynamics. Malaysia and Thailand can be considered intermediate markets which leaves India and Indonesia as genuine emerging markets among Asian reporting countries (see “Sustainable debt dynamics – Asia private sector credit”).
Global NFC and HH debt ratios (Source: BIS; CMMP)
New terms of reference are required for analysing global debt trends that distinguish between economies with excess HH and/or corporate debt and the rest of the world. In this case, excess refers to levels that are above the BIS thresholds. Among the BIS reporting economies (and excluding Luxembourg) there are:
Eight economies with excess HH and NFC debt levels: Hong Kong, Sweden, the Netherlands, Norway, Denmark, Switzerland, Canada and South Korea
Eleven economies with excess NFC debt levels: Ireland, France, China, Belgium, Singapore, Chile, Finland, Japan, Spain, Portugal, and Austria
Three economies with excess HH debt levels: Australia, New Zealand, the UK
The RoW with HH and NFC debt levels below the BIS thresholds
These classifications provide a more appropriate foundation for further analysis of the other, key features of global debt – its rate of growth and its affordability. These will be addressed in subsequent posts.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Addressing a major weakness in the current debate about debt
The key chart
Trends in COCO- and FIRE-based lending (EUR bn, % total) since 2005 (Source: ECB; CMMP)
The key message
A major weakness in the current debate about debt in the “post-Covid world” is the failure to distinguish adequately between different forms of credit.
CMMP analysis, in contrast, draws a clear distinction between productive, “COCO-based” credit and less-productive, “FIRE-based” credit (see “Fuelling the FIRE, the hidden risk in QE”). This enabes a more accurate critique of current macro policy and a better understanding of the implications of unorthodox monetary policy (QE).
The shift towards greater levels of FIRE-based lending pre-dates the introduction of QE, but it was not until July 2016 that this form of credit exceeded COCO-based lending for the first time in the EA. The latest ECB data shows that FIRE-based lending now accounts for 52% of total lending (November 2020) reinforcing my September 2019 message that the “hidden risk in QE is that the ECB is ‘fuelling the fire’ with negative implications for leverage, growth, financial stability and income inequality in the EA.”
COCO- versus FIRE-based lending – the key concepts
In the broadest sense, lending can be spilt into two distinct types: lending to support productive enterprise; and lending to finance the sale and purchase of existing assets. The former includes lending to NFCs and HH consumer credit, referred collectively here as “COCO” credit (COrporate and COnsumer). The latter includes loans to non-bank financial institutions (NBFIs) and HH mortgage or real estate debt, referred to collectively as “FIRE” credit (FInancials and Real Estate). Dirk Bezemer (www.privatedebtproject.org) neatly distinguishes between the productivity of these different forms of lending:
COCO-based lending typically supports production and income formation
CO: loans to NFCs are used to finance production which leads to sales revenues, wages paid, profits realised and economic expansion. Bezemer notes that these loans are used to realise future cash revenues from sales that land on the balance sheet of the borrower who can then repay the loan or safely roll it over. The key point here is that an increase in NFC debt will increase debt in the economy but it will also increase the income required to finance it
CO: consumer debt also supports productive enterprises since it drives demand for goods and services, hence helping NFCs to generate sales, profits and wages. It differs from NFC debt to the extent that HH take on an additional liability since the debt does not generate income. Hence the consumer debt is also positive but has a slightly higher risk to stability
Trends in outstanding stock of COCO-based loans since 2005 (Source: ECB; CMMP)
FIRE-based lending typically supports capital gains through higher asset prices
FI: loans to NBFIs (eg, pension funds, insurance companies) are used primarily to finance transactions in financial assets rather than to produce, sell or buy “real” output. This credit may lead to an increase in the price of financial assets but does not lead (directly) to income generated in the real economy
RE: mortgage or real estate lending is used to finance transactions in pre-existing assets rather than transactions in goods and services. Such lending typically generates asset gains as opposed to income (at least directly)
Trends in outstanding stock of FIRE-based loans since 2005 (Source: ECB;CMMP)
Lending in any economy will involve a balance between these different forms, but the key point is that a shift from COCO-based lending to FIRE-based lending reflects different borrower motivations and different levels of risks to financial stability.
COCO- versus FIRE-based lending – the evidence from the euro area
Split in lending between COCO-based and FIRE-based credit (Source: ECB; CMMP)
At the end of November 2020, COCO-based lending in the EA totalled EUR 5,437bn. This is below the peak level of EUR 5,517bn recorded in January 2009. FIRE-based lending, in contrast, totalled EUR 5,792bn, 26% higher than the outstanding stock as at the end of January 2009. As can be seen in the chart above, FIRE-based lending exceeded COCO-based lending for the first time in July 2016. The current split of total loans is now 52% FIRE-based and 48% COCO-based, compared with respective shares of 45% and 55% in January 2009.
NFC lending as a percentage of GDP since 2005 (Source: BIS; CMMP)
In other words, the shift towards increased FIRE-based lending pre-dates the introduction of QE in the EA. The shift becomes more noticeable in the post-GFC period and may also reflect the fact that NFC debt levels (expressed as a percentage of GDP) had exceeded the threshold level that the BIS considers detrimental to future growth for most of this period (see chart above).
COCO- versus FIRE-based lending – the impact of QE
Nevertheless, as noted back in September 2019, the hidden risk in QE is that the ECB is “Fuelling the FIRE” with potentially negative implications for leverage, growth, financial stability and income inequality in the Euro Area.
As noted above, while COCO-based lending increases absolute debt levels, is also increases incomes (albeit with a lag), hence overall debt levels need not rise as a consequence. In contrast, FIRE-based lending increases debt and may increase asset prices but does not increase the purchasing power of the economy as a whole. Hence, it is likely to result in high levels of leverage.
Similarly, COCO-based lending supports economic growth both by increasing the value-add from final goods and services (“output”) and an increase in profits and wages (“income”). In contrast, FIRE-based lending typically only affects GDP growth indirectly.
From a stability perspective, the returns from FIRE-based lending (investment returns, commercial and HH property prices etc) are typically more volatile that returns from COCO-based lending and may affect the solvency of lenders and borrowers.
Finally, the return from FIRE-based lending are typically concentrated in higher-income segments of the populations, with any subsequent wealth-effects increasing income inequality.
Please note that the summary comments above are abstracts from more detailed analysis that is available separately
Banks may deliver poor LT investment returns but their interaction with the wider economy provides important insights for corporate strategy, investment returns and asset allocation (#1).
Starting from a simple understanding of core banking services, we can build a quantifiable, objective and logical analytical framework linking all domestic sectors with each other and with the rest of the world (#2).
This framework allows us to challenge official UK forecasts that assume unprecedented behaviour and dynamism from UK households and corporates in support of unsustainable outcomes (#3).
It also allows us to debunk EA myths and identify the key factors that will determine the shape of any recovery in Europe and investment returns in 2021 (#4).
The messages from the UK and EA money sectors during the pandemic have been very similar, albeit with the UK demonstrating higher gearing to current dynamics, including any return to normality (#5).
They also contrast sharply with the messages associated with previous periods of monetary expansion (#6).
Finally, humility and a willingness to unlearn the so-called lessons of the past is important, especially in relation to banking and macroeconomics. The outlook for 2021 will depend, largely, on whether policy makers are willing to challenge orthodox fiscal thinking (#7).
Humility and the willingness to unlearn the lessons of the past
Lesson #7
The final lesson is the importance of humility and a willingness to unlearn the lessons of the past, especially in relation to banking and macroeconomics. It is, after all, only six years since the Bank of England debunked the widely taught and held view that banks act simply as intermediaries, lending out deposits that savers place with them.
In the current context of large-scale fiscal responses to the pandemic, its will be important to see how other (so-called) lessons from the past are treated e.g. governments should budget like households, governments spend taxpayers money, deficits are evidence of over-spending/crowding out of the private sector, Chancellors have moral duties to balance the books etc.
The shape and duration of any recovery and investment returns in 2021 will depend, for example, on whether the notion that fiscal expansion is indispensable to sustain demand is fully understood or not (#4). Will 2020-21 be a watershed moment in macro understanding/policy?
In this context, I am ending this series of summary posts with a link to a recent article published by David Andolfatto of the Federal Reserve Bank of St Louis on 4 December 2020. This important article may foreshadow a shift in macro policy understanding. In line with my preferred financial sector balances approach (#2), Andolfatto questions the “government as a household” analogy and also notes that, to the extent that government debt is held domestically, it constitutes wealth for the private sector. From here, and more significantly, he argues that:
“…it seems more accurate to view the national debt less as a form of debt and more as a form of money in circulation…The idea of having to pay back money already in circulation makes little sense, in this context. Of course, not having to worry about paying back the national debt does not mean there is nothing to be concerned about. But if the national debt is a form of money, wherein lies the concern?”
“Does the National Debt Matter?” Federal Reserve Bank of St. Louis, December 2020
Wherein indeed? Delicious food-for-thought for the Festive Season and for 2021…
Similar messages, but is the UK more geared to recovery?
The key chart
What is the expansion in broad money in the UK and EA telling us? (Source: ECB; Bank of England; CMMP analysis)
Lesson #5
The UK and EA money sectors have been sending very similar messages during the pandemic, albeit it with more volatile YoY trends in the UK. Broad money is growing at the fastest rate since April 2008 in both regions with narrow money’s contribution to total money also reaching historic highs.
The overriding message here is that uncertainty reigns with HHs and NFCs maintaining a preference for holding highly, liquid assets despite earning negative/very low real returns. From a counterparts perspective, above trend NFC credit and resilient mortgage demand have been offsetting weak consumer credit. But again, the dominate message is one of subdued credit demand – the gap between money supply and private sector credit demand continues to hit new highs.
“Uncertainty” and “subdued credit demand” are four key words missing from the inflation hawks’ current narrative!
Looking forward, the key unknown is the extent to which increased savings are forced or precautionary. The OBR may be too optimistic in the assumed extent of recovery in HH consumption, but there is evidence here to suggest that the UK is likely to demonstrate a higher ST gearing to a return to normality than the EA.
Debunking myths and identifying key drivers of future returns
The key chart
So far, so good – but is the wider notion that fiscal expansion is indispensable fully understood? (Source: Eurostat, CMMP analysis)
Lesson #4
In addition to helping challenge UK official forecasts (lesson #3), financial sector balances (lesson #2) have also allowed us to debunk three myths from the euro area and identify the key factors that will determine the shape and duration of any recovery and investment returns in 2021.
Back in April 2020, I challenged the arguments that: (1) painful structural reforms post-2000 were the main driver of Germany’s recovery and resurgent competitiveness; (2) existing fiscal frameworks (including the Stability and Growth Pact) were still relevant; and (3) “this crisis [was] primarily the hour of national economic policy.”
Focusing here on (2), in response to COVID-19, EA households increased their savings sharply and corporates stopped investing. The ECB called correctly for fiscal responses, “first and foremost” and the EU and European governments responded appropriately with a shift to more proactive and common fiscal policies.
Policy makers have acknowledged that private sector investment is unlikely to fill the gap left by COVID-19.
So far, so good. The wider question (see also lesson #7) is whether the notion that fiscal expansion is indispensable to sustain demand is fully understood.
