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.
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.
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:
The risk of a Chinese balance sheet recession dominated 2023 and will DOMINATE 2024 too
“US bears” ignored structural shifts in US debt dynamics post-GFC and underestimated the RESILIENCE OF THE CONSUMER as a result
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
The ECB’s policy celebrations may prove PREMATURE
UK policy making is still based on UNBELIEVABLE forecasts and FLAWED macro thinking
Banks are failing to support PRODUCTIVE ACTIVITY and the SME sector in particular
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
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.
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.
US consumer credit dynamics weaken further in October 2023
The key chart
Trends in monthly flows of US consumer credit (Source: FRED; CMMP)
The key message
“Cracking – part II”, the update – US consumer credit dynamics weaken further in October 2023.
Quarterly US consumer credit flows in 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, released yesterday (7 December 2023) suggests that momentum is weakening further at the start of 4Q23.
The three-month moving average of flows fell to $1.7bn in October 2023, down from $4.4bn in September and $4.6bn in August and down from the recent April 2022 peak of $32.9bn. Perhaps more importantly, the latest flows are only a fraction of the pre-pandemic average flow of $14.8bn.
Trends in monthly flows of US consumer credit (Source: FRED; CMMP)
The strength of consumer credit demand between April 2021 and April 2023 (see charts above) helps to explain the resilience of US consumption in the post-COVID period, especially in relation to trends observed in the euro area and the UK.
Flows peaked in April 2022, however, and since then, the 2Q23 flows were revised down and momentum has continued to slow in 3Q23 and into the final quarter of the year.
In short, the message from the US money sector is one of weaker consumer credit dynamics and elevated risks to US consumption and the growth outlook.
Focus on the flows…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Private sector debt service ratios (1Q23) compared with deviations from respective LT averages since 1999 (Source: BIS; CMMP)
The key message
Private sector “affordability risk” is an increasing focus of attention as we move to a “higher-for-longer” rate environment. The focus typically centres on the US private sector. Is this justified or more a reflection that we live in a highly US-centric world of financial reporting?
The debt service ratio (DSR) is the ratio of interest payments plus amortisations to income. It provides a flow-to-flow comparison ie, the flow of debt service payments divided by the flow of income. The BIS compiles this data using a unified methodological approach, but compilation challenges mean that comparisons that include both the absolute level and the deviation from respective LT averages are more useful than comparisons of absolute levels alone. The chart above plots private sector DSRs (x-axis) for BIS reporting nations in relation to the deviation from LT averages since 1999 (y-axis).
The US private sector DSR was 14.9% at the end of 1Q23. This compares with a LT average of 15.5% and the high of 18.3% recorded in 3Q07. As can be seen, the US private sector DSR is neither high in absolute terms nor in terms of the deviation from its LT average when viewed in a global context.
The latest BIS data release suggests that attention would be focused better on “affordability risks” in developed economies including Canada, Switzerland, Sweden, France and Finland and emerging markets including Brazil, China and Korea instead. In these cases, the latest DSRs are both high in absolute terms and in relation to their respective LT averages.
Perspective matters….
Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.
Quarterly consumer credit flows expressed as a multiple of pre-pandemic average flows (Source: FRED; BoE; CMMP)
The key message
In May 2023, I asked, “have US and UK consumers read the recession script?” I noted that, “despite rising borrowing costs, quarterly consumer credit flows in 1Q23 remained above pre-pandemic levels. Fast-forward another quarter and the question remains largely the same – when will US and UK consumers read the recession script?
Contrasting consumer credit dynamics suggests divergent growth outlooks for investors and different challenges for the Federal Reserve, the Bank of England and the ECB.
US consumer credit demand has moderated from its elevated 2022 levels, but remains above pre-pandemic average levels. UK consumer credit demand remains surprisingly resilient, and above pre-pandemic levels too. Chair Powell and Governor Bailey face similar challenges as consumers continue to borrow to support consumption despite rising borrowing costs.
The contrast with consumer credit dynamics in the euro area (EA) is sharp. EA consumer credit demand remains subdued and well below pre-pandemic levels. President Lagarde faces a very different balancing act between weaker growth/recession and lower inflation.
In short, the messages from the US, UK and EA money sectors remind us that the risks of policy errors remain elevated in all three regions but for contrasting reasons…
When will US and UK consumers read the recession script?
Quarterly US consumer credit flows (Source: FRED; CMMP)
US consumer credit demand is moderating sharply but remains above pre-pandemic levels. Quarterly flows of consumer credit have fallen from $87bn in 4Q22 to $52bn in 1Q23 and $50bn in 2Q23, but remain above their pre-pandemic level of €45bn (see chart above).
Monthly US consumer credit flows (Source: FRED; CMMP)
The monthly flow of US consumer credit was more volatile during the 2Q23 (see chart above). Flows ranged from $22.3bn (1.5x pre-pandemic average) in April 2023 to only $9.5bn (0.6x pre-pandemic average) in May 2023 and then $17.8bn (1.2x pre-pandemic flow) in June 2023.
Quarterly UK consumer credit flows (Source: BoE; CMMP)
UK consumer credit demand remains surprisingly resilient. Quarterly flows increased from £3.1bn in 4Q22 to £4.5bn in 1Q23 and £4.3bn in 2Q23. These flows were 0.9x, 1.2x and 1.2x the pre-pandemic average quarterly flow of £3.6bn (see chart above).
Monthly UK consumer credit flows (Source: BoE; CMMP)
Monthly flows during the 2Q23 were £1.6bn, £1.1bn and £1.7bn in April, May and June 2023 respectively. These flows were 1.6x, 1.1x and 1.7x the pre-pandemic average flows respectively. (see chart above).
Quarterly EA consumer credit flows (Source: ECB; CMMP)
Euro area consumer credit demand remains consistently subdued, in sharp contrast to trends observed in both the US and the UK. Quarterly flows have fallen from €5.2bn in 4Q22 to €4.2bn in 1Q23 and €3.4bn in 2Q23, the lowest quarterly flow since 2Q21 (see chart above). Quarterly flows have failed to recover to their pre-pandemic level of €10.3bn.
Monthly EA consumer credit flows (Source: ECB; CMMP)
Monthly flows have also declined during the quarter from €2.0bn in April to €1.3bn in May to only €23m in June 2023 (see chart above). As noted in previous posts, the fact that demand for consumer credit remains very subdued in absolute terms and in relation to trends observed in the US and the UK makes the ECB’s tasks slightly easier (while elevating policy risks at the same time).
Conclusion
Contrasting consumer credit dynamics suggests divergent growth outlooks for investors and different challenges for the Federal Reserve, the Bank of England and the ECB.
Demand is moderating sharply in the US but remains resilient and above the levels seen pre-pandemic, at least so far. UK demand also remains surprisingly resilient and above pre-pandemic levels, at least for the time being (and as suggested by OBR forecasts). Chair Powell and Governor Bailey face similar challenges as consumers continue to borrow to support consumptions despite rising borrowing costs.
In contrast, the message from the money sector for EA growth is much weaker and presents President Lagarde with a very different balancing act between weaker growth/recession and lower inflation.
The risks of policy errors remain elevated in all three regions but for contrasting reasons…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Be careful how you present your data and what you include.
The key chart
Long term trends in US GDP, public debt and private debt plotted on log scales (Source: FED; CMMP)
The key message
Further thoughts for those “seeking to create panic” over US public debt – (1) do not use log scales when presenting data graphically, and (2) do not include private sector debt in your analysis.
In my previous post, I illustrated how using linear scales (absolute levels) was better for creating panic than using log scales (rate of change). Recall that long time-series data that has low initial values and a constant growth rate (eg US public debt) lends itself very well to creating so-called “panic charts” (see chart below).
“Panic charts” in action (Source: CMMP)
The reason not to use log scales is simple. They emphasise instead, how the rate of growth has (1) been relatively constant over time, and (2) slower now than in early parts of the period.
Excluding private debt is a second key tactic. Since current macro thinking typically ignores private debt altogether while seeing public debt as a problem, this is relatively straightforward and uncontroversial.
What are the risks of ignoring this advice?
First, readers may compare its rate of growth (the green line in the key chart above) with the rates of growth in public debt (blue line) and nominal GDP (maroon line). They may note the extended period (1948-2007) when the rate of growth in private debt far outstripped the rate of growth in both GDP and public debt (the private debt ratio rose from 48% GDP to 165% of GDP).
Second, and from this, readers may explore the relationship between public and private debt growth rates (buying Amazon’s last copy of Wynne Godley’s, “Monetary Economics” in the process). They may note that during phase 1 (4Q1940 – 4Q1981) the public debt ratio fell from 86% GDP to 32% GDP. In other words, the net wealth of the non-government sector parked in a savings account marked “treasuries” grew at a much slower rate than GDP. They may realise that in response, the private sector borrowed more. A lot more. The private debt ratio increased from 48% GDP to 99% GDP.
From here, attention may shift naturally to the two periods of relatively high rates of growth in public debt – Phase 2 (3Q81 – Reaganomics – 3Q93) and the post–GFC Phase 4 (2Q07 – 1Q13). In phase 2, the public debt ratio rose from 32% GDP to 70% GDP. Private debt continued to grow but at a much slower place (to 118% GDP). In phase 4, the expansion of public debt reflected the government’s response to the GFC and the subsequent deleveraging of the private sector (the private debt ratio fell from 165% GDP to 149% GDP).
There are two risks here. First, attention may be drawn to the minority-held view (so far) that private debt typically causes crises while public debt typically limits their impact. Second, it may also be drawn to the fact that the US led the advanced world in the structural shift away from relatively high risk private debt to lower risk public debt in the post-GFC period.
To repeat and extent the message from the previous post – it is always worth considering how different parties chose to present their data to support their arguments and also to consider what they chose to include, or more importantly, exclude….
50 years of US public sector debt dynamics – plotted differently! (Source: FED;CMMP)
The key message
If you wanted to create panic over US public sector debt there are a number of tactics that you could use:
ignore the fact that US debt is a liability for one economic sector and an asset for another;
make no comparison with GDP;
ignore inflation etc.
Alternatively, you could simply present your data using linear scales – an easier and almost guaranteed method to instil panic!
1 unit of XZY growing at 10% p.a. over 100 years plotted on a linear scale (Source: CMMP)
Why is this a smart tactic for creating panic?
In the case of any long time series data that has low initial values and a constant growth, the use of a linear scale will always create a chart that is flat for a long period at the start, then becomes steeper and steeper before becoming virtually vertical (see chart above). Readers’ eyes will naturally focus on the steepening of the graph, thereby leading to the conclusion that some form of critical limit has been reached
BINGO – “PANIC ALERT!”
In contrast, the wrong tactic for creating panic would be to present data using a log scale (the maroon line in the key chart). Rather than illustrating the absolute level of US debt (the blue area) this would show its rate of change.
As can be seen, this is (1) fairly constant over time (US debt roughly doubles every ten years in nominal terms) and (2) is slower now than in early parts of the period shown. Presented this way (see chart below), the same underlying data is much less likely to create panic…
1 unit of XZY growing at 10% p.a. over 100 years plotted on a log scale (Source: CMMP)
For the rest of us, it is worth considering how different parties chose to present the same data to support their respective arguments, especially as concerns (false or otherwise) over the US debt ceiling intensify.
Remember, a chart of US public debt using a linear scale is highly likely to create panic, even if the rate of change of debt is constant.
A tempting question to ask, but also the wrong one!
The key chart
Twenty-year trends in debt ratios (% GDP) broken down by type (Source: BIS; CMMP)
The key message
Denmark and the US are the only two, advanced economies that maintain absolute limits on the level of government debt. Interestingly, their public debt ratios (as opposed to debt levels) were essentially the same twenty years ago (54-55% GDP). Today, however, Denmark has the third lowest public debt ratio in the world (30% GDP), while the US has the seventh highest (103% GDP).
Unsurprisingly perhaps, while we hear little “political noise” about the Danish debt ceiling (or debt ratio), we are subjected to an overdose from the US. This leads some to ask, “Why can’t the US be more like Denmark”.
A tempting question to ask, but also the wrong one…
To understand why, we need to adopt a systemic view of the Danish and US financial systems that incorporates both public and private sector debt and reflects the reality of modern money creation.
Put simply, money creation relies on actions that add to bank deposits. Bank lending and government DEFICITS (despite what is taught in many textbooks) qualify, but in different ways. The repayment of bank loans and government SURPLUSES have the opposite effect – they destroy money.
In this context, a better question to ask is, “How do the processes of money creation in Denmark and the US differ and why does this matter?”
Total debt ratios have increased in both economies over the past two decades (see key chart above). In Denmark from 223% GDP to 246% GDP. In the US from 198% GDP to 256% GDP. The processes have been very different, however.
Denmark has effectively substituted government deficits and public debt (an asset of the non-government sector) with more private debt (a liability of the non-government sector) over the past two decades. In contrast, the US has substituted private debt – mainly household debt – with more public debt. In the process, the ratio of the stock of private debt (largely ignored by policy makers and economists) to public debt has risen from 3.2x to 7.2x in Denmark over the period. In the US, it has fallen from 2.6x to 1.5x.
The key point here it that private sector money creation faces unique supply (capital and regulation) and demand (ability of currency users to service debt) constraints. Despite more than a decade of HH sector deleveraging, for example, Denmark’s HH and NFC debt ratios remain above the levels where debt is considered a constraint on future growth. The result? Further private sector deleveraging, led by the HH sector.
Private sector models are also inherently less flexible, less stable and, in advanced economies, more prone to periods of crisis that require greater to levels of public debt to resolve/address.
While lending to the private sector is also the main source of money creation in the US, the government plays a much greater role than in Denmark. As a currency issuer, the US government does not face the same constraints as the private sector (although it does face other constraints). The US is also one of only three advanced economies where both HH and NFC debt ratios are below their respective threshold limits. In short, the structure of the US model provides more flexibility and more stability, as the response to the COVID-pandemic illustrated, and reduces the risk of crisis.
The US generates significantly more political noise about the management of government debt than Denmark, the only other country to maintain an absolute debt ceiling. This noise differential in not an accurate reflection of the relative strengths of the money creation processes in each economy. It is instead, a reflection of flawed macro thinking. Thinking that views public sector debt as a problem but largely ignores private debt and falsely equates the financial constraints of currency users and currency issuers.
The irony here is that a more accurate, systemic view of Danish and US money creations leads to a different question altogether – “Shouldn’t Denmark be more like the US?”
Why can’t the US be more like Denmark?
Twenty-year trends in public sector debt ratios (% GDP) (Source: BIS; CMMP)
Denmark and the US are the only two, advanced economies that maintain absolute limits on the level of government debt. Their public debt ratios (as opposed to debt levels) were essentially the same twenty years ago (54% and 55% GDP respectively, see graph above). Today, however, Denmark has the third lowest public debt ratio in the world (30% GDP, see graph below), while the US has the seventh highest (103% GDP).
BIS reporting nations ranked by 3Q22 public debt ratios (% GDP) (Source: BIS; CMMP)
Unsurprisingly, while we hear little political noise about the Danish debt ceiling (or debt ratio), we are subjected to an overdose of “political noise” from the US. This leads some to ask, “Why can’t the US be more like Denmark”. A tempting question to ask, but also the wrong one…
Money creation in Denmark and the US – a systemic view
To understand why, we need to adopt a systemic view of the Danish and US financial systems that incorporates both public and private sector debt and reflects the reality of modern money creation.
Money creation relies on actions that add to bank deposits, the main form of money today. Bank lending and government deficits (despite what is taught in many textbooks) qualify, but in different ways. The repayment of bank loans and government surpluses have the opposite effect – they destroy money.
In this context, a better question to ask is, “How do the processes of money creation in Denmark and the US differ and why does this matter?”
The changing nature of money creation – total debt broken down by type (% total debt) (Source: BIS; CMMP)
The graph above illustrates how Denmark has effectively substituted public debt (an asset of the non-government sector) with more private debt (a liability of the non-government sector) over the past two decades. In contrast, the US has substituted private debt – mainly household debt – with more public debt.
Note the relative scale of the stock of private sector debt (largely ignored by policy makers and economist) in relation to the stock of public sector debt over the period (see graph above). In Denmark, the ratio rose from 3.3x to almost 10x before the GFC, fell back and then rose again to 7.2x today. Again, in contrast, the US ratio has fallen from 2.6x to 1.5x over the period.
Twenty-year trends in Danish money creation (debt as % GDP) (Source: BIS; CMMP)
In other words, lending to the private sector is a far more important source of money creation in Denmark (see graph above) than in the US (see below). As an aside, the Danish government ran a budget surplus in 2022, destroying money in the process.
The key point here it that private sector money creation faces unique supply (capital and regulation) and demand (ability of currency users to service debt) constraints. Despite more than a decade of HH sector deleveraging, for example, Denmark’s HH and NFC debt ratios remain above the level where debt is considered a constraint on future growth (see graph below). For reference, the BIS considers that HH and NFC debt ratio of 85% GDP and 90% GDP represent threshold limits above which debt becomes a constraint on future growth.
HH debt ratios plotted against NFC debt ratios for selected BIS reporting nations – red lines represent BIS threshold limits (Source: BIS; CMMP)
The result? Further private sector deleveraging, led by the HH sector (see chart below). Note also that private sector models are also inherently less flexible, less stable and, in advanced economies, more prone to periods of crisis that require greater to levels of public debt to resolve/address.
Twenty-year trends in US and Danish HH and NFC debt ratios (% GDP) (Source: BIS; CMMP)
While lending to the private sector is also the main source of money creation in the US, the government plays a much greater role than in Denmark (see chart below). As a currency issuer, the US government does not face the same constraints as the private sector (although it does face other constraints). The US is also one of only three advanced economies where both HH and NFC debt ratios are below their respective threshold limits.
In short, the structure of the US model provides more flexibility and more stability, as the response to the COVID-pandemic illustrated, and reduces the risk of crisis.
Twenty-year trends in US money creation (debt as % GDP) (Source: BIS; CMMP)
Conclusion – shouldn’t Denmark be more like the US?
The US generates significantly more political noise about the management of government debt than Denmark, the only other country to maintain an absolute debt ceiling. This noise differential in not an accurate reflection of the relative strengths of the money creation processes in each economy. It is instead, a reflection of flawed macro thinking. Thinking that views public sector debt as a problem but largely ignores private debt and falsely equates the financial constraints of currency users and currency issuers.
The irony here is that a more accurate, systemic view of Danish and US money creation leads to a different question altogether – “Shouldn’t Denmark be more like the US?”
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
