#strategy – Page 7 – Chris Mallin Macro Perspectives

“Challenging flawed narratives”

Four challenges to the “over-indebted US economy” narrative

The key chart

**Share of outstanding non-financial debt by sector** (Source: FED, CMMP)

The key message

The latest “Financial Accounts of the United States” published by The Federal Reserve at the end of last week challenges the popular, but flawed, narrative of an “over-indebted US economy”.

This narrative typically focuses on the outstanding stock of US nonfinancial debt, which hit another new high of $67.6 trillion at the end of 2Q22. Mistakenly, however, it ignores:

The significant shift away from private to public sector debt. The structure of US debt is now the mirror image of its pre-GFC structure following the shift away from relatively high-risk household (HH) debt towards lower-risk government debt (see key chart above)
The on-going, passive deleveraging of the HH sector. The HH debt ratio has fallen from its peak of 99% GDP at the end of 1Q08 to 75% at the end of 2Q22, very slightly above its post-GFC low
The relatively low levels of business (NFC) and HH indebtedness in a global context. The US is one of only three, BIS-reporting advanced economies with both NFC and HH debt ratios below the BIS threshold limits (above which debt becomes a constraint on future growth)
Key distinctions between public and private sector debt and their implications. Government debt represents financial wealth for the private sector, hence its position on the asset side of the private sector’s balance sheet. Furthermore, governments do not face the same constraints as the private sector. As a currency issuer, the US government cannot become insolvent in its own currency since it can always make payments as they come due in its own currency.

CMMP analysis believes that it is more accurate to view public sector debt as money in circulation rather than as debt in its more widely-held sense. In this context, “the idea of having to pay back money already in circulation [another feature of the flawed narrative] makes little sense.” (Alfonso, 2020. “Does the National Debt Matter?”)

Challenging flawed narratives

**Trend in outstanding stock of US non-financial debt in $ trillions** (Source: FED; CMMP)

According to the latest financial accounts, the outstanding stock of US nonfinancial debt reached $67.6 trillion at the end of June 2022 (see chart above).

Federal debt of $26.3 trillion accounted for 39% of total debt, followed by NFC debt of $19.5 trillion (29% total), HH debt of $18.6 trillion (27% total) and state and local debt of $3.3 trillion (5% total). The total debt ratio fell to 272% GDP, down from 307% GDP in 2Q20 at the height of the COVID-19 pandemic.

The structure of US debt is now the mirror image of the structure that existed before the global financial crisis (GFC). At the end of 2Q07, HH debt accounted for 43% of outstanding nonfinancial debt, followed by NFC debt 30% and public sector debt (federal, state and local) 27%. Today (at the end of 2Q22), public sector debt accounts for 44% of outstanding debt, followed by NFC debt 29% and HH debt 27%. This represents a very significant structural shift away from relatively high-risk HH debt towards lower-risk government debt in the post-GFC period (see chart above).

**Trends in HH debt ($ tr) and the HH debt ratio (% GDP)** (Source: FED; CMMP)

The HH debt ratio has fallen from a peak of 99% GDP at the end of 1Q08 to 75% at the end of 2Q22 (see chart above). The peak level was 14ppt above the threshold level of 85% GDP above which debt is believed to be a constraint on future growth. The current level is slightly above its post-GFC low of 74% at the end of 4Q19.

The post-GFC period has been one of passive HH deleveraging.

**Trends in HH and NFC debt ratios** (Source: FED; CMMP)

The US is one of only three BIS-reporting advanced economies that has both HH and NFC debt below the maximum BIS threshold limits (along with Germany and Italy). The NFC debt ratio currently stands at 78% GDP, down from a recent high of 91% GDP at the end of 2Q20. For reference, the BIS maximum threshold limits for HH and NFC debt are 85% GDP and 90% GDP respectively (see chart above).

As shown in the chart below, the US private sector debt ratio of 153% GDP is now only slightly above the 145%-150% GDP range that characterised much of the past decade up until the COVID pandemic.

**Trends in private sector debt ratio (% GDP)** (Source: FED; CMMP)

Important distinctions exist between private sector and public sector debt, including:

While private sector debt is debt sitting on the liability side of the private sector’s balance sheet, government debt represents financial wealth for the private sector and sits on the asset side of the private sector’s balance sheet
As currency users, HHs and NFCs face obvious constraints on their levels of debt. “Taking on too much debt can, and does, lead to bankruptcy, foreclosure, and even incarceration” (Kelton, 2020)
In contrast, as a currency issuer, the US government cannot become insolvent in its own currency since it can always make payments as they come due in its own currency

CMMP analysis believes that it is more accurate to view public sector debt as money in circulation rather than as debt in its more widely-held sense. In this context, “the idea of having to pay back money already in circulation [another feature of the flawed narrative] makes little sense” (Alfonso, 2020. “Does the National Debt Matter?”).

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

“Three key aspects – reinforced!”

China data reinforces three key aspects of global debt dynamics

The key chart

**The chart from 2019 – China’s HH credit growth outstripping GDP growth despite the fact that the HH debt ratio was close to the average for all BIS reporting countries** (Source: BIS; CMMP)

The key message

This week’s news of weaker-than-expected economic growth in China and on-going challenges in the country’s property sector reinforces three key aspects of global debt dynamics:

Conventional macro thinking is flawed to the extent that it typically ignores the risks associated with private debt (while seeing government debt as a problem)
The “EM-debt” story has, for some time, been replaced by the “China-debt” story – strip out China and EM’s share of global debt is largely unchanged since the GFC
The level of any country’s debt needs to be considered in relation to its rate of growth (and its affordability and structure).

In an early 2019 CMMP Analysis report (“Too much, too soon?“), I concluded that:

“The risks associated with excess HH credit growth in China remain elevated and this analysis presents a relatively extreme example of the importance of considering the level of debt together with its rate of growth. History suggests that current trends in China are unsustainable. The most benign outcome is that the rate of growth in HH borrowing slows more rapidly with negative implications for consumption and aggregate demand. In short, China’s increasing HH debt burden represents a key headwind in the transition to a consumption-driven economy.”

Debt dynamics matter, a lot, but conventional approaches to understanding them need updating.

“Accounting for inflation”

Inflation distorts the 2Q22 messages from the money sector

The key chart

**Nominal and real growth rates in EA private sector credit** (Source: ECB; CMMP)

The key message

Rising inflation distorts the 2Q22 messages from the euro area’s (EAs) money sector significantly.

Ignore inflation and the three key signals that I have been following consistently since early 2021 are all sending broadly positive messages for the region’s economic outlook. Monthly household (HH) deposit flows have moderated sharply, reflecting lower levels of uncertainty. The demand for consumer credit has recovered with the largest quarterly flows since the recovery began in 2Q21. Growth rates in money supply and private sector credit have also re-aligned as money and credit cycles have re-synched with each other. Finally, the contribution of productive COCO-based lending has increased, with growth in lending to corporates (NFCs) outstripping mortgage growth in June 2022. So far, so good.

Take inflation into account and the messages are very different, however. Private sector credit (PSC) is slowing in real terms (-2.3% YoY). With the exception of lending to non-monetary financial corporations (8% of total PSC), the growth rates in all forms of PSC are declining in real terms. Furthermore, trends in real M1, real HH credit and real NFC credit are all slowing sharply in a coordinated manner. This matters because these factors typically display leading, coincident and lagging relationships with real GDP.

Plenty of information for optimists and pessimists to debate but with increasing ammunition for the pessimists…

Accounting for inflation

Rising inflation distorts the 2Q22 messages from the euro area’s (EAS) money sector significantly.

The good news

Ignore inflation and the messages are broadly positive for the region’s economic outlook.

**Trends in monthly HH deposit flows** (Source: ECB; CMMP)

Monthly HH deposit flows have moderated sharply, reflecting lower levels of uncertainty. The monthly flow fell to €9bn in June 2022 (see chart above). This is well below the average pre-pandemic flows of €33bn and the peak flow of €78bn in April 2020 when HH uncertainty levels peaked at the height of the pandemic crisis.

**Quarterly trends in HH deposit flows** (Source: ECB; CMMP)

The quarterly HH deposit flow in the 2Q22 was €53bn (see chart above). This compares with average quarterly pre-pandemic flows of €90bn. The message here is the same – HHs in the EA are no longer hoarding cash in the form of bank deposits. This is reflected, in turn, in the slowdown in broad money growth (see below).

**Trends in monthly consumer credit flows** (Source: ECB; CMMP)

The demand for consumer credit has recovered. Monthly consumer credit flows slowed from €2.4bn in April 2022 and €3.3bn in May 2022 to €1.8bn in June 2022 (see chart above). The YoY growth rate of 3.3% was the second highest rate of growth since consumer credit recovered in April 2021, however (after May 2022’s 3.4% YoY).

**Quarterly trends in consumer credit** (Source: ECB; CMMP)

The quarterly flow of consumer credit in 2Q22 of €7bn was the largest quarterly flow since the recovery started in 2Q21. There have now been five consecutive quarters of positive consumer credit flows (see chart above), albeit these flows remain below the pre-pandemic levels.

**Growth trends in broad money (M3) and private sector credit** (Source: ECB; CMMP)

After the recent unprecedented de-synchronisation of money and credit cycles, growth rates in EA money supply and private sector credit have now converged (see chart above).

The YoY growth rate in broad money (M3) fell to 5.7% in June 2022, the slowest rate of growth since February 2020. In contrast, the growth rate in private sector credit rose to 6.1% YoY, the fastest rate of growth since private sector credit growth turned positive in Mach 2015.

Recall that in January 2021, the gap between the growth rate in M3 and the growth rate in private sector credit was 8ppt. In June 2022, private sector credit grew faster than broad money, suggesting that the period of excess liquidity (see green shaded area in graph above) may be ending.

**Trends in PSC and contribution from COCO-based lending** (Source: ECB, CMMP)

The contribution of productive COCO-based lending is also increasing with the growth in lending to corporates (NFCs) outstripping the growth in mortgages. COCO-based lending contributed 2.5ppt to the total (unadjusted) growth rate in private sector credit of 5.8% (see chart above). This compares with a contribution of only 0.6ppt a year earlier.

Less productive FIRE-based lending is still contributing more (3.3ppt) than COCO-based lending to total loan growth, but corporate lending is now growing faster (5.9% YoY) than mortgage lending (5.3% YoY). Corporate and mortgage lending represent the largest segments of COCO-based and FIRE-based lending respectively.

**Growth trends (% YoY, nominal) in mortgages and NFC lending** (Source: ECB; CMMP)

The bad news

Take inflation into account and the messages are very different, however. PSC is growing 6.1% YoY in nominal terms, the fastest rate of growth since January 2009. In real terms, however, PSC is falling -2.3% YoY. With the exception of lending to non-monetary financial corporations (8% of total PSC), the growth rates in all forms of PSC are declining in real terms.

**Growth trends (% YoY, real terms) in M1, HH credit and NFC credit** (Source: ECB; CMMP)

Furthermore, trends in real M1, real HH credit and real NFC credit are all slowing sharply in a coordinated manner. This matters because these factors typically display leading, coincident and lagging relationships with real GDP over time. (See “Look beyond the yield curve” for more details about these indicators)

Conclusion

The three key signals from the money sector that we have been following consistently since early 2021 are all sending broadly positive messages – HHs have stopped hoarding money, they are borrowing more to fund consumption, and money and credit cycles are re-synching. The on-going recovery in productive COCO-based lending is also positive.

Rising inflation is over-taking these positive trends, however. PSC is falling in real terms and traditional leading, coincident and lagging monetary indicators have turned down sharply and in a coordinated fashion. Plenty of ammunition here for pessimists…

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

“Financial inequality and debt vulnerability”

The BoE introduces an improved measure of affordability

The key chart

**Share of outstanding mortgages and consumer credit by income decile** (Source: BoE; CMMP)

The key message

Rising financial inequality means that lower-income HHs have less flexibility to adjust their spending in response to rising prices and are less likely to have a cushion of savings to protect them. But what does this mean for debt vulnerability in the UK, given that lower-income HHs also hold a relatively small share of outstanding mortgages and consumer credit?

In its latest “Financial Stability Review” (5 July 2022), the Bank of England introduced a new measure of HH debt affordability that takes account of these factors to deliver an improved assessment of HH vulnerability to rising prices and higher interest rates. The key points are:

The share of HHs with high, adjusted debt service ratios (DSRs) i.e. those who are typically more likely to struggle with repayments, is currently in-line with historic averages and well below pre-GFC peaks
The BoE believes that this share is unlikely to rise substantially in 2022. Further fiscal measures will cushion serviceability this year and the shift towards fixed mortgages (80% outstanding stock) delays the pass through effect of higher rates
Looking forward, the BoE expects this share to increase above its historic average in 2023, but to remain “significantly below the peaks seen ahead of the GFC.”

[In response to questions, Sir Jon Cunliffe, the Deputy Governor for Financial Stability, indicated that rates would have to rise significantly (200-500bp) above current market expectations for the bank rate (3.0%) for the share to reach previous highs.]

The obvious risks to this positive assessment, acknowledged by the BOE, include weaker growth, higher unemployment, persistent inflation, higher rates etc.

In the context of the recent deterioration in the net lending position of the HH sector, the risk that HHs may increasing their borrowing in order to fund rising living costs also remains important.

Financial inequality and debt vulnerability

What is the impact of financial inequality on household (HH) debt vulnerability?

Financial inequality means that lower-income HHs have less flexibility to adjust their spending in response to rising prices and are less likely to have a cushion of savings to protect them.

**Share of income spent on taxes and essentials by gross income decile** (Source: BoE; CMMP)

The share of income spent on essentials and taxes varies considerably across the UK income distribution (see chart above). HHs in the lowest income decile, for example, spend 94% of their gross income on taxes and essentials. In contrast, HHs in the highest income decile spend only 47% of their gross income on taxes and essentials. This means that lower-income HHs have much less freedom to change their behaviour in response to rising inflation.

**HH savings ratio (%) broken down by gross income decile** (Source: BoE; CMMP)

The savings ratio of lower-income HHs is also much lower than the savings ratio of higher-income HHs (see chart above). HHs in the bottom three income deciles save less than 6% of their gross income. This contrasts with HHs in the top two income deciles who save more than 30% of their gross income.

Obviously, this means that lower-income HHs are much less likely to have a savings cushion than can protect against rising prices. ( Note also that the COVID-19 pandemic led to a further widening of the savings disparity in the UK, as noted in previous posts.)

That said, lower income HHs are also likely to hold a smaller share of both outstanding mortgages and consumer credit (see chart above).

**Share of outstanding mortgages by income decile** (Source: BoE; CMMP)

The bottom three income deciles account for 1.6%, 1.2% and 2.3% of total outstanding mortgages respectively, a cumulative market share of just over 5% (see chart above). The top income decile accounts for 33% of total mortgages alone and the top three income deciles together account for more than two-thirds of total mortgages.

The breakdown of consumer credit follows a similar, if less extreme, pattern. The bottom three income deciles account for 1.5%, 3.0% and 4.0% respectively, a cumulative market share of just over 8% (see chart below). The top income decile accounts for 20% of total consumer credit alone and the top three income deciles accounts for more than half of total consumer credit.

**Share of outstanding consumer credit by income decile** (Source: BoE; CMMP)

In its latest “Financial Stability Review”, the Bank of England introduces a new measure of HH debt affordability that takes account of these factors to deliver an improved assessment of the HH vulnerability to rising prices and higher interest rates.

The BoE claims that, “the share of HHs with high cost of living adjusted DSRs on either their mortgage or consumer credit has remained significantly below the pre-GFC peaks over the past few years.”

**Share of HHs with high adjusted DSR on mortgage debt** (Source: BoE; CMMP)

In the case of mortgages, the BoE estimates that 1.7% of HHs had a high, adjusted DSR at the end of 1Q22, up from 1.4% in 1Q20. This is close to the historic average but below the pre-GFC peak of 2.8% (see chart above). The BoE is expecting this share to remain at around the current level for the rest of 2022. This assumes that government support measures will relieve the pressure of rising living costs and also reflects the fact that 80% of outstanding mortgages are fixed rate now versus 55% five years ago.

**Share of HHs with high adjusted DSR on consumer credit** (Source: BoE; CMMP)

The story for consumer credit is much the same. The share of high, adjusted DSRs for consumer credit was 6.4% in 1Q22, up from 5.5% in 1Q20. This is also well below the pre-GFC peak of 9.5%. Again, the BOE is not expecting a major change here during the rest of 2022.

Looking slightly further ahead, the BoE believes that the shares of HHs with a high, adjusted DSR for both mortgages and consumer credit will increase in 2023, but “would remain significantly below the peaks seen ahead of the GFC.”

In response to questions, Sir Jon Cunliffe, the Deputy Governor for Financial Stability, indicated that rates would have to rise significantly (200-500bp) above current market expectations for the bank rate (3.0%) for the share to reach previous highs.

The obvious risks to this positive assessment, acknowledged by the BOE, include weaker growth, higher unemployment, persistent inflation, higher rates etc. In the context of the recent deterioration in the net lending position of the HH sector, the risk that HHs may increasing their borrowing in order to fund rising living costs also remains important.

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

“Don’t be surprised – part 2”

Short-term comfort but more serious medium-term concerns

The key chart

**UK net lending (+) / net borrowing (-) by sector from the capital account as % age of GDP**
(Source: ONS; CMMP)

The key message

Two official UK data points released last week – the 1Q22 household (HHs) savings ratio and May 2022’s consumer credit growth – provide short-term comfort but may hide more serious medium-term concerns for the UK economic outlook.

The positive news: HHs have room to adjust to falling real incomes by running down savings and increasing borrowings further. The adjustment process here remains at an early stage (see “Don’t be surprised”).

The negative news: while the net lending position of the HH sector widened slightly in 1Q21 (0.9% GDP), the UK private sector, in aggregate, moved into a net borrowing position (-1.4% GDP). At the same time, the public sector increased its net borrowing position further (-6.7% GDP).

So what? The irony of post-Brexit Britain, is that the economy is currently more dependent than ever on the net lending of the RoW. The challenges of the pre-Covid period have returned already – twin domestic deficits counterbalanced by significant (and persistent?) current account deficits.

These trends are not unexpected but that does not mean that they are either welcome or sustainable.

Don’t be surprised – part 2

Two official UK data points released last week – the 1Q22 HHs savings ratio and May 2022’s consumer credit growth – provide short-term comfort but medium-term concerns for the UK economic outlook.

**Real HH disposable income growth (% QoQ)** (Source: ONS; CMMP)

The context here is that real HH disposable income has fallen for four consecutive quarters (see chart above). Official forecasts suggest that this will continue for the rest of 2022 and in 2023.

In response, the same forecasts assume that HHs will reduce their savings ratio to a new low in 1Q23 by running down the excess savings built up during the pandemic (see chart below) and/or by increasing their borrowing. The positive news is that this process has hardly begun.

**Trends in HH savings ratio** (Source: ONS; OBR; CMMP)

The 1Q22 HH savings ratio was 6.8%, unchanged from the 4Q21 and above the OBR’s forecast of 6.3% (see chart above). Of course, this represents a large decline from the 2Q20 peak of 23.9%, but the 1Q22 ratio is only slightly below the 20-year average of 7.1%. (Note that the OBR expects the savings ratio to fall further to 2.8% in 1Q23.)

**Monthly HH money flows as a multiple of pre-pandemic flows** (Source: BoE; CMMP)

Furthermore, while monthly HH money flows have moderated sharply, they remain slightly above pre-pandemic levels during 2Q22 (see chart above). The result? Rather than declining, the stock of excess savings is increasingly slightly still (see chart below). CMMP analysis estimated that excess savings currently total £167bn.

**CMMP estimates for build up of excess savings** (Source: BoE; CMMP)

As an aside, the ONS also released the results of its modelling of the breakdown of the excess savings last week. The modelling suggests that so-called “forced savings” accounted for 75% of the increase in HH savings during the pandemic.

**Estimates for excess savings broken down by type** (Source: BoE; ONS; CMMP)

According to their calculation, this amounts to over £140bn, or around 10% of annual disposable income. This matters because forced savings are typically released relatively quickly to support economic activity (see “Forced versus precautionary”).

**Monthly flows (£bn) and YoY growth rates in consumer credit** (Source: BoE; CMMP)

Consumer credit grew 5.7% YoY in May 2022, unchanged versus the previous month (see chart above). This is the fastest rate of growth since February 2020 (5.8%) due in part to base effects. The monthly flow of consumer credit in May 2022 fell, however, from £2.0bn in February, £1.3bn in March, and £1.4bn in April 2022 to £0.8bn. May’s monthly flow is also below the pre-pandemic average of £1.1bn.

**HH debt to income ratio (%)** (Source: ONS; CMMP)

In other words, the demand for consumer credit has recovered – a welcome trend – but is not increasing at a rate that would suggest significant levels of distressed borrowing. HH debt as a percentage of disposable income, while elevated in absolute terms, has remained relatively stable since 2015 and below the peaks seen in the built up to the GFC.

So far, so good. Recent trends reflect a return to normality and suggest that HHs still have room to adjust to falling real incomes. It is not all good news, however. In “Don’t be surprised”, I highlighted the negative implications of forecast trends for both financial equality and economic sustainability. Last week’s data also shines further light on question of economic sustainability.

**HH net lending/borrowing (% GDP)** (Source: ONS; CMMP)

The net lending of the UK HH sector, i.e. the surplus resources that the HH sector makes available to other sectors, rose from 0.6% GDP in 4Q21 to 0.9% GDP in 1Q22 (see chart above). However, the UK private sector in aggregate shifted from a net lending position of 4.3% GDP in 4Q21 to a net borrowing position of 1.4% of GDP.

When combined with the net borrowing of the UK public sector of 6.7% in 1Q22, the UK’s net borrowing position with the rest of the world increased to 8.4% GDP (see chart below).

The irony of post-Brexit Britain, is that the 1Q22 net borrowing position with the rest of the world exceeds the previous highest borrowing seen in 4Q201 (7.0% GDP).

With both domestic sectors currently running net borrowing positions, the UK is more dependent than ever on net lending from the RoW (see chart above).

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

“Anatomy of a currency crisis!?!”

…or the risks of USD dollar-centricity in financial/economic reporting

The key chart

**Sterling effective exchange rate** (Source: BoE; CMMP)

The key message

I posted a comment on LinkedIn last week about a so-called “basket-case” currency that is currently trading above its five-year average levels despite a host of negative economic, political and market-related factors.

The currency in question was the pound sterling and the graph illustrated the narrow version of the sterling exchange rate index (ERI) as calculated and published daily by the Bank of England (see key chart above).

The “tongue-in-cheek” post reflected an increasing frustration with excessive USD dollar-centricity in current financial and economic reporting.

**USD – Sterling exchange rate** (Source: BoE; CMMP)

Trends in bilateral exchange rates such as USD to sterling are important, of course, The US is the UK’s largest individual trading partner after all, and sterling is currently trading 7% below its five-year average versus the USD (see chart above). This is noteworthy in itself.

**Sterling ERI weights** (Source: BoE; CMMP)

That said, the UK economy is affected by (and reflected in) movements in sterling against many different currencies. As a bloc, the EU is the UK’s largest trading partner, for example. The region accounts for roughly double the US’s share of UK trade (see chart above). Sterling is currently trading 2% ABOVE is five-year average versus the EURO (see chart below), which helps to explain the trend in sterling’s ERI illustrated above (see key chart).

**EURO – Sterling exchange rate** (Source: BoE; CMMP)

This is not to deny that sterling is trending weaker, increasing the risk of imported inflation in the process. The sterling ERI has fallen 4% YTD. But, for a UK-audience at least, it is helpful to explore the extent to which reported trends in the bilateral exchange rate with the US are a reflection of USD strength as opposed to sterling weakness.

Perhaps the more important question, is why is sterling actually not trading much weaker than it is now?

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

“Don’t be surprised”

Look beyond the headlines with this week’s UK macro data

The key chart

**UK HH savings ratio (%, SA)** (Source: ONS; CMMP)

The key message

Surprise and sensational headlines may follow the release of two UK data points this week – the 1Q22 household savings ratio (ONS, Thursday) and consumer credit growth for May 2022 (BoE, Friday). Neither would be justified.

Official UK forecasts already assume (1) that real household disposable income will fall in 2022 and 2023, and (2) that the savings ratio will fall to a record low at the start of 2023, in response. In practice, this means that some UK HHs will run down the c£166bn of excess savings built up during the pandemics while others take on more debt.

We know from the “messages from the UK money sector” that HH monthly money flows (savings) are already trending back towards pre-pandemic levels and that monthly consumer credit flows have recovered to exceed pre-pandemic levels over the past three months. Nothing surprising nor sensational so far. Indeed both trends reflect an important return to normality after the pandemic.

That said, current trends are not all “good news.” There are negative implications here for both financial equality and economic sustainability.

Excess savings have typically accrued to HHs that already have sizable savings, have higher incomes, and are much older. These HHs typically spend less from any extra savings they accumulate. In contrast, lower-income HHs, with higher marginal propensities to consume, are more likely to borrow more to support consumption. The result? Greater financial inequality in the UK.

The OBR’s forecasts also assume that the UK HH sector ultimately moves from its traditional role as a net lender to the rest of the economy to being a sustained net borrower. Such a transition would involve remarkable role reversals from the pandemic period when the government took exceptional measures to protect HH incomes from the full effect of the crisis. More concerning here is the fact that the implied shift to replace public borrowing with more private borrowing reflects the flaw in conventional macro thinking that typically ignores the risks associated with private debt while seeing government debt as a problem rather than as a solution.

Unfortunately, this is neither new nor surprising news either.

“Don’t be surprised”

Surprise and sensational headlines may follow the release of two UK data points this week – the household savings ratio (ONS, Thursday) and consumer credit growth (BoE, Friday). Neither would be justified.

**Latest (March 2022) OBR forecasts for real HH disposable income (% YoY)** (Source: OBR; CMMP)

Recall that in March 2022, the OBR’s “Economic and fiscal outlook” forecast that real household (HH) disposable income will fall by 1.5% this calendar year and by 0.2% in 2023, before recovering steadily to average 1.7% from 2024 onwards (see chart above).

**OBR forecasts for UK savings ratio** (Source: OBR; CMMP)

In the face of weaker real income growth, the OBR already expects HHs to save less than previously forecast and for the savings ratio to reach a record low of 2.8% by the start of 2023. In practice, “the lower saving ratio will reflect some HHs running down excess savings while others take on more debt” (Economic and Fiscal Outlook, March 2022).

**CMMP estimates for build up of excess savings (£m)** (Source: BoE; CMMP)

Since the start of the COVID-19 pandemic, UK HHs have accumulated excess savings of c£166bn in the form of bank deposits (see chart above). We know from the “messages from the money sector”, however, that monthly HH money flows have moderated back towards pre-pandemic levels during 2022. In April 2022, these flows totalled £5.7bn, 1.2x the average pre-pandemic flows. At their peak in May 2020, these monthly flows had reached £26bn, 5.5x pre-pandemic levels (see chart below).

We also know that consumer credit borrowings over the past three months have been higher than the average pre-pandemic monthly borrowings. In February, March and April 2022, HHs borrowed £2.0bn, £1.3bn and £1.4bn respectively. These flows compare with the pre-pandemic average of £1.0bn. The annual growth rate of consumer credit also increased to 5.7% YoY in April 2022 from 5.2% in March 2022, the highest YoY growth rate since February 2020 (see chart below).

Nothing surprising nor sensational so far. Indeed both trends reflect an important return to normality after the pandemic. That said, these current trends are not all “good news.” There are negative implications here for both financial inequality and economic sustainability.

**Trends and forecasts for HH net lending/borrowing as % GDP** (Source: OBR; CMMP)

The OBR’s forecasts also assume that the UK HH sector ultimately moves from its traditional role as a net lender to the rest of the economy to being a sustained net borrower (see chart above).

Such a transition would involve remarkable role reversals from the pandemic period when the government took exceptional measures to protect HH incomes from the full effect of the crisis. More concerning here is the fact that the implied shift to replace public borrowing with more private borrowing reflects the flaw in conventional macro thinking that typically ignores the risks associated with private debt while seeing government debt as a problem rather than as a solution.

Unfortunately, this is neither new nor surprising news either.

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

“Resilient so far, but…”

UK card payments remain above pre-pandemic levels

The key chart

**Aggregate monthly card payments versus pre-pandemic levels** (Source: ONS; CMMP)

Two-thirds of the way through 2Q22, and the message from the UK money sector is still one of resilient consumer spending. But what are households (HHs) spending their money on and why does it matter?

According to the latest ONS data (9 June 2022), monthly spending on credit and debit cards was 104% of its pre-pandemic, February 2020 level. This is 18ppt higher than in January 2022 and 6ppt higher than in May 2021 (see chart above).

All spending categories rose in the week to 1 June according to the shorter-term, daily CHAPS-based indicator. While the overall message from the shorter-data remains the same, it is important to note that spending is concentrated on getting to work and on staples ie, spending more on basic items (see chart below).

**Card payments (seven-day rolling average) to 1 June 2020 by type** (Source: ONS; CMMP)

In contrast, while spending on delayable goods such as clothing and furniture is recovering, it remains 8ppt below pre-pandemic levels.

This matters, because spending on delayables is a key indicator of whether the excess savings built up during the pandemic are returning to the economy in a sustained manner.

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

“Attenzione!”

Time for new solutions to Italy’s structural problems

The key chart

**Trends in private and public sector net lending/borrowing over the past decade**
(Source: ECB; CMMP)

The key message

With the yield on Italian 10Y government bonds rising to 3.37% (+251bp YTD), attention is focusing again on the net borrowing of the Italian government and the government debt ratio (172% GDP).

This is entirely consistent with conventional macroeconomic thinking that continues to ignore private debt while seeing public debt as a problem. It is also mistaken.

A key theme of CMMP analysis is that, “private debt causes crisis – public debt (to some extent) ends them” (Professor Steve Keen, June 2021). Italy, of course, stands out as being one of only four developed market economies that has household (HH) and corporate (NFC) debt ratios well below the maximum threshold levels above which the BIS believes that debt becomes a constraint on future growth.

Not only does Italy not have a private sector debt problem, some of the economy’s key challenges stem from a lack of private sector borrowing and investment, not from too much. Consider:

The Italian private sector has been a consistent (and growing) net lender over the past decade. Instead of borrowing money to invest, HHs and NFCs have been saving/disinvesting. The outstanding stock of NFC debt at end 3Q21 was below the level recorded in 3Q09, for example.
The net savings of the private sector have been running at 1.5-3.0x the size of the net borrowings of the government. Instead of funding the fiscal stimulus required to close Italy’s deflationary gap, un-borrowed private sector savings have leaked out of the economy.
“Austerity” and future fiscal consolidation have not/will not solve either of these fundamental challenges. Domestic sector imbalances leave the Italian economy increasingly reliant of running current account surpluses. The structural challenges of excess savings and insufficient private sector investment remain.

The fact that un-borrowed savings in countries experiencing private sector deleveraging are able to leak into other bond markets, restricting governments from funding stimulus measures, reflects a structural flaw in the Eurozone. In 2012, Richard Koo, the Japanese economist and global expert on balance sheet recessions, proposed applying different risk weights to domestic and foreign government bonds as a partial solution.

Perhaps the time for new and imaginative solutions to Italy’s sector imbalances is at hand, once again…

Attenzione!

**Top 10 government debt ratios, ranked by size** (Source: BIS; CMMP)

With the yield on Italian 10Y government bonds rising to 3.37% (+251bp YTD), attention is focusing once again on the net borrowing of the Italian government and the government debt ratio (which is the third highest in the world at 172% GDP). This is entirely consistent with conventional macroeconomic thinking that continues to ignore private debt while seeing public debt as a problem. It is also mistaken.

**HH and NFC debt ratios for BIS advanced economies** (Source: BIS; CMMP)

A key theme of CMMP analysis is that, “private debt causes crisis – public debt (to some extent) ends them” (Professor Steve Keen, June 2021). Italy, of course, stands out as being one of only four developed market economies that has HH and NFC debt ratios well below the maximum threshold levels above which the BIS believes that debt becomes a constraint on future growth (see chart above).

According to the latest BIS statistics, Italy’s HH and NFC debt ratios are only 44% GDP and 73% GDP respectively. This compares with average debt ratios in the euro area of 61% GDP and 111% GDP (EA in the chart above) and BIS threshold levels of 85% GDP and 90% GDP respectively (red lines in chart above).

Not only does Italy not have a private sector debt problem, some of the economy’s key problems stem from a lack of private sector borrowing and investment, not from too much.

**Net lending of Italy’s private sector over the past decade** (Source: ECB; CMMP)

The Italian private sector been a consistent (and growing) net lender over the past decade (see chart above). Instead of borrowing money to invest, HHs and NFCs have been saving/disinvesting (see chart below). NFC debt of €1,277bn at the end of 3Q21 was below the €1,305bn recorded at the end of 3Q2009, for example. Over the same period, HH debt has increased by only 1.3% CAGR from €660bn to €764bn.

**Trends in HH and NFC debt and debt ratios since 2009** (Source: BIS; CMMP)

The net savings of the private sector have been running at 1.5-3.0x the size of the net borrowings of the government. Instead of funding the fiscal stimulus required to close Italy’s deflationary gap, un-borrowed private sector savings have leaked out of the economy.

**Trend in private sector net lending versus public sector net borrowing** (Source: ECB; CMMP)

“Austerity” and potential future fiscal consolidation have not/will not solve either of these fundamental challenges. Domestic sector imbalances leave the Italian economy increasingly reliant of running current account surpluses with the RoW (see chart below). The structural challenges of excess savings and insufficient private sector investment remain.

**Trends in Italian net sector balances (EURbn)** (Source: ECB; CMMP)

In “The escape from balance sheet recession and the QE trap”, Richard Koo, the Japanese economist and leading authority on balance sheet recessions, highlighted the structural flaw in the Eurozone that allowed un-borrowed savings in countries experiencing private sector deleveraging to flee to other bond markets, preventing domestic governments from issuing debt to fund stimulus measures.

As far back as 2012, Koo proposed applying different risk weights to domestic and foreign government bonds. He suggested that, “The relatively minor regulatory change of attaching different risk weights to holdings of domestic versus foreign government bonds would go a long way toward reducing pro-cyclical and destabilising flows among government bond markets.”

Perhaps the time for new and imaginative solutions to Italy’s sector imbalances is at hand, once again…

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

“Euro area re-synching – part 2”

The implications for asset allocation

The key chart

**The sharp and co-ordinated slowdown in EA money and private sector credit (% YoY, real)**
(Source: ECB; CMMP)

The key message

What are the implications of the re-synching of euro area money and credit cycles for asset allocation and what are the current messages from the money sector telling us?

Growth rates in narrow money (M1) and loans to the private sector display relatively robust relationships with the business cycle over time. M1, household (HH) and corporate (NFC) credit also enjoy leading, coincident and lagging relationships with GDP respectively and can be very useful inputs into asset allocation processes, therefore.

The recovery in money and credit cycles in the post-GFC period broadly followed this stylised pattern. Other macro-factors complicated the wider interpretation of these trends, however. Interest rate effects (initially) and the COVID-19 pandemic (more recently) had a more important impact on narrow money growth than cyclical factors, for example. At the same time, extended periods of private sector deleveraging resulted in HH and NFC credit growth lagging GDP growth for much of the past decade.

That said, the overall message has been clear – while money growth has exceeded GDP growth over the past decade, credit growth has lagged it. The consequences for macro policy choices of this extended dynamic was clear, even before the pandemic hit.

With money and credit cycles re-synching now, inflation is the key challenge in interpreting current messages from the money sector.

Optimists might note that the slowdown in monetary growth reflects a sharp moderation in deflationary money flows into overnight deposits, and will be encouraged by the resilient HH and recovering NFC credit demand (in nominal terms).

In contrast, pessimists might prefer the more traditional approach described above. For them, the very sharp and co-ordinated slowdown in money and credit growth in real terms with be a far more alarming message, especially for those positioned for economic recovery.

Euro area re-synching – part 2

As a macro strategist, economist and global investor, I have always been interested in the relationship between money, credit and business cycles and the implications for asset allocation.

**The recovery in money and credit followed the stylised pattern post-GFC (% YoY, real)**
(Source: ECB; CMMP)

The recovery in money and credit cycles followed this stylised pattern in the post-GFC period (see chart above). Real M1 bottomed in July 2011 (-1.4%) and turned positive in May 2012. Real HH credit bottomed next in September in 2012 (-2.3%) and turned positive in December 2014. Finally, real NFC credit bottomed in June 2013 (-4.6%) and turned positive in November 2015. Other macro-factors complicated the wider interpretation of these trends, however.

**Trends (% YoY) in real GDP and real M1** (Source: ECB; CMMP)

Interest rate effects (initially) and the COVID-19 pandemic (more recently) had a more important impact on narrow money growth than cyclical factors, for example (see chart above).

Interest rate and cyclical effects are typically the main factors affecting trends in narrow money, with the latter being more relevant for asset allocation purposes.

While real M1 continued to exhibit leading indicator qualities, strong demand for overnight deposits (within M1), driven by their increasing low opportunity cost, suggest that interest rate effects had a greater impact than cyclical factors over much of the past decade. The COVID-19 pandemic also resulted in dramatic increases in forced and precautionary savings, again largely in the form of overnight deposits. This compounded the challenges of interpreting these dynamics (see “Don’t confuse the message”).

**Trends (% YoY) in real GDP and real HH credit** (Source: ECB; CMMP)

At the same time, extended periods of private sector deleveraging resulted in HH and NFC credit growth lagging GDP growth for much of the past decade.

The chart above illustrates how real HH credit has enjoyed a broadly coincident relationship with GDP for most of the period. That said, it also shows that the EA HH sector was engaged in an extended period of passive deleveraging between March 2010 and March 2019 with real growth in HH credit lagging real growth in GDP.

Similarly, the chart below illustrates how NFC credit has also enjoyed a broadly lagging relationship with real GDP growth. Again, the analysis and interpretation is challenged by an extended period of NFC deleveraging. Growth in NFC credit lagged behind real GDP growth from December 2009 to May 2016 and to July 2018, in a more sustained fashion.

**Trends (% YoY) in real GDP and real NFC credit** (Source: ECB; CMMP)

**Monthly HH deposit flows as a multiple of pre-pandemic levels** (Source: ECB; CMMP)

With money and credit cycles re-synching now, inflation is the key challenge in interpreting current messages from the money sector. Optimists might note that the slowdown in monetary growth reflects a sharp moderation in deflationary money flows into overnight deposits (see chart above), and will be encouraged by the resilient HH and recovering NFC credit demand, in nominal terms (see chart below).

**Growth trends (% YoY, nominal) in HH and NFC credit** (Source: ECB; CMMP)

In contrast, pessimists might prefer the more traditional approach described above. For them, the very sharp and co-ordinated slowdown in money and credit growth in real terms (see chart below) will be a far more alarming message, especially for those positioned for economic recovery.

**The alarming and coordinate slowdown in real money and credit growth** (Source: ECB; CMMP)

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