Trends in net lending/net borrowing, EURbn, rolling 4Q sum (Source: ECB)
The key message
Comments made by the Governor of the Banque de France in Paris last week (1) confirm that conventional macro thinking continues to (largely) ignore private debt while seeing public debt as a problem, and (2) suggests that reports of the death of out-dated fiscal rules in the euro area (EA) are premature.
What did he say? The Governor rejected arguments that (1) accommodative monetary policy was responsible for the rise in public debt, and (2) that “because of this high public debt, monetary policy is now unable to raise interest rates sufficiently to combat inflation”. He stressed that central bank independence was “notably designed to prevent any risk of fiscal domination.” The rest of the speech focused on why debt must remain a key issue and the future EA fiscal rules.
From a CMMP analysis perspective, there were three extraordinary features of the speech:
First, in discussing the exceptional (fiscal) response to exceptional circumstances, the Governor ignored the similarly exceptional disinvestment by the French private sector;
Second, and linked to this, he suggested that France “could keep the 3% deficit target, which is as a “useful anchor” and even the 60% debt target”;
Finally, he chose not to refer to the elevated risks associated with the level, growth or affordability of risks associated with French private sector debt, particularly in the corporate (NFC) sector..
Why does this matter? The Governor’s speech follows similar arguments presented earlier this year by the French state auditor. In both cases, the level of public sector debt was viewed as a problem but private sector debt was ignored, confirming a fundamental flaw in conventional macro thinking. The support for out-dated and arbitrarily determined fiscal rules also means that the risks of deficit reductions compounding further private sector deleveraging in the future remain.
Plus ça change, plus c’est la même chose…
Sonnez l’alarme II – the charts that matter
Trends in French public sector net borrowing (EURbn) since 1999 (Source: ECB)Trends in French and German government debt ratios (% GDP) versus fiscal target (Source: BIS) Trends in French private sector net lending (EURbn) since 1999 (Source: ECB)The view from a sector balances perspective (Source: ECB)Breakdown (% total) of French credit to the non-financial sector (Source: BIS)Rolling 3-year CAGR in NFC credit versus 3-year CAGR in nominal GDP (Source: BIS)French NFC sector debt ratio versus BIS maximim threshold limit (Source: BIS)French NFC debt service ratio versus LT average since 1999 (Source: BIS)EA private and public sector balances, EURbn (Source: ECB)
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Monthly credit and debit card payments in relation to pre-pandemic levels (Source: ONS)
The key message
The latest ONS “real-time” indicators (12 May 2022) confirm the resilience of the UK consumer during 2Q22.
Monthly card spending in April was 2% above pre-pandemic levels, 16ppt higher than in January 2022. Daily card spending rose to 110% pre-pandemic levels in the week to 5 May 2022, with rises across all segments. Spending on so-called “delayable” goods continues to recover but is the only segment where current spending is still below pre-pandemic levels. This matters because spending on delayable goods is the best indicator that the excess savings built up during the pandemic are returning to consumption in a sustainable fashion.
Despite the threat of rising inflation and falling real incomes, UK consumers continue to “bash the plastic”. They are spending more on getting to work and on staples, however, than on items such as clothing and furniture. So positive news, but only up to a point.
A full recovery in spending on delayable goods is required before we can have confidence that the UK consumption recovery is sustainable.
Still bashing the plastic – the charts that matter
The latest ONS “real-time indicators” (12 May 2022) confirm the resilience of the UK consumer through 2Q22, at least so far. Monthly card spending (see chart above) in April was 102% pre-pandemic levels, 16ppt higher than in January 2022 (87%) and 9ppt higher than April 2021 (93%).
Daily aggregate card spending in relation to pre-pandemic levels (Source: ONS)
Daily card spending (rolling seven-day) also increased by 8ppt in the week to 5 May 2022 to reach 110% of pre-pandemic levels (see chart above). Spending rose across all categories, with the largest growth seen in “social” spending. “Work-related”, “staple” and “social spending” are currentl 131%, 120% and 113% pre-pandemic levels (see chart below).
Current card spending by type versus pre-pandemic levels (Source: ONS)
Spending on “delayable” goods such as clothing and furniture is recovering (see chart below), but remains 5% below pre-pandemic levels. This matters because delayable spending is our preferred indicator regarding the extent to which excess savings are returning to the economy in a sustained fashion.
Card spending on delayable goods versus pre-pandemic levels (Source: ONS)
Conclusion
UK consumers continue to “bash the plastic” despite the challenges of rising inflation and falling real incomes. This is positive news. Consumers are spending more on getting to work and on staples, however, than on items such as clothing and furniture. A full recovery in spending on delayable goods is required before we can have confidence that current consumption is sustainable.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
UK aggregate and delayable goods card payments in relation to pre-pandemic levels (Source: ONS; CMMP)
The key message
UK households (HHs) are delaying their spending on so-called “delayable” goods such as clothing and furniture. This matters for two reasons:
First, spending on delayable goods is our preferred proxy for the return of the excess savings built up during the pandemic to productive use;
Second, a key assumption in the latest OBR forecasts for the UK economy and public finances is that HHs will run down their excess savings (and increase their borrowing) to fuel consumption in the face of declining real wages.
The message from the money sector so far this year is that UK aggregate spending is recovering steadily but the sustainability of consumption remains unproven. HHs are spending more on getting to work, for example, but less on buying clothes, furniture and other durable goods.
In short, the accumulation of excess savings may have slowed but we await further evidence that these savings are being run down to support sustained consumption as the OBR expects.
Delaying the delayable in charts
Delayable goods payments in relation to pre-pandemic levels (Source: ONS; CMMP)
UK households (HHs) are delaying their spending on so-called “delayable” goods such as clothing and furniture. According to the latest ONS real-time indicators, credit and debit card purchases on delayable goods in the week to 17 March 2022 were 82% of their February 2020 average (see chart above). This means that delayable spending is currently the weakest segment of HH spending. Spending on work-related, staples, and social goods and services are currently 17%, 9% and 5% above pre-pandemic levels (see chart below).
UK card spending in relation to pre-pandemic levels (ppt) broken down by type (Source: ONS; CMMP)
This matters for two reasons. First, spending on delayable goods is our preferred proxy for the return of the excess savings built up during the pandemic to productive use. Second, and related to this, a key assumption in the latest OBR forecasts for the UK economy and public finances is that HHs will run down their excess savings (and increase their borrowing) to fuel consumption in the face of declining real wages (see “Good news for Rishi, but…”).
Aggregate UK card spending in relation to pre-pandemic levels (Source: ONS; CMMP)
The message from the money sector so far this year is that UK aggregate spending is recovering steadily (see chart above) but the sustainability of consumption remains unproven. HHs are spending more on getting to work, for example, but less on buying clothes, furniture and other durable goods (see chart below).
Delayable versus work-related card spending in relation to pre-pandemic levels (Source: ONS; CMMP)
In short, UK HH’s accumulation of excess savings may have slowed but we await further evidence that these savings are being run down to support sustained consumption as the OBR expects.
Please nore that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Trends and forecasts for public sector net borrowing as % GDP (Source: OBR; CMMP)
The key message
In its “Economic and fiscal outlook”, the Office of Budget Responsibility (OBR) delivered mixed messages for the UK economy and public finances.
The headlines are likely to focus on the forecast that the government’s borrowing will narrow to -1.1% GDP by 1Q27. This would be the lowest budget deficit for 25 years (£32bn) and music to the ears for a Chancellor who believes in his moral responsibility to balance the budget.
The forecasts assume (1) dramatic role reversals in the position of the UK government vis-à-vis the household (HH) sector and (2) sustained and significant current account deficits throughout the forecast period. They also present a more subdued outlook for business investment.
The key risks lie in the assumption that, in the face of falling real incomes, HHs will maintain consumption via reducing their savings ratio to a record low and/or increasing borrowing further (despite high HH debt ratios).
Beyond these risks, there are two further problems with these latest OBR forecasts:
First, the assumed end-position envisages BOTH domestic sector sectors running persistent net deficits beyond 4Q22, leaving the UK reliant on the RoW as a net lender. Such a scenario appears neither attractive nor sustainable;
Second, and more fundamentally, the implied shift away from public debt to private debt reflects the persistent flaw in conventional macro thinking that typically ignores the risk associates with private debt while seeing public debt as a problem rather than a solution.
Faced with these two problems, I believe that the greatest value in these forecasts lies in the insights they provide into the key drivers and assumptions that lie behind current policy and thinking. From there, we can all form our own views as to the likelihood of them being achieved in reality…
Good news for Rishi, but…
Trends and forecasts for public sector net borrowing as % GDP (Source: OBR; CMMP)
The OBR provided good news for Rishi Sunak, the UK Chancellor, in its latest “Economic and fiscal outlook” published on Wednesday 23 March 2022.
The UK government’s net borrowing position has already narrowed to -10.1% GDP (3Q21) versus previous expectations of -11.4%. More significantly, the OBR expects this to narrow to -1.1% by 1Q27 compared with previous forecasts of -1.5% (see chart above). This would represent the lowest budget deficit for 25 years (£31.6bn). Music to the ears for a Chancellor who believes in a moral responsibility to balance the budget.
Key OBR assumptions
Trends and forecasts for HH net borrowing as % GDP (Source: OBR; CMMP)
The key assumption behind the OBR’s forecasts is that the HH sector 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 a period when the “Government took exceptional measures to protect HH incomes from the full effect of one crisis (the pandemic) to one in which imported cost rises force HHs to save less to cushion the blow to real spending” (OBR, March 2022).
In short, to move to a net lender position, HHs would need to either reduce their savings and/or increase their borrowings.
Trends and forecasts for HH savings ratio (Source: OBR; CMMP)
The OBR forecasts a more dramatic reduction in the HH savings ratio than previously, to a record low of 2.8% by the start of 2023 (see chart above). This would allow HHs to maintain their consumption levels in the face of the expected fall in real incomes.
To support this assumption, the OBR notes that HHs have, “saved around £230bn more than in the equivalent period before the pandemic, of which around £185 billion is held in highly liquid deposits.” This is true but much of these excess savings have accrued to HHs that already have sizable savings, have higher incomes, and are much older. Such HHs typically spend less from an extra savings they accumulate.
With the OBR also forecasting that the savings ratio will remain at around 5% through their forecast period, below the LT average of around 8%, the risks to this assumption lie to the downside, in my view.
UK household debt ratio (% GDP) (Source: BIS; CMMP)
The OBR argues that, “in practice the lower savings ratio will reflect some HHs running down excess savings while other take on more debt.” In that context, it is worth noting that the HH debt ratio has fallen from its peak of 97% GDP in 1Q10 to 88% GDP at the end of 3Q21. Nonetheless, it remains above the BIS maximum threshold level, above which debt becomes a drag in future growth (see chart above).
While the cost of servicing debt remains very low, the overall debt ratio suggests that HHs may be reluctant to increases borrowing levels dramatically from current levels.
Trends and forecasts for NFC net borrowing as % GDP (Source: OBR; CMMP)
In another example of assumed role reversals, the OBR expects the NFC sector to remain a net lender until 2Q25 (see chart above). Note that NFC sectors are typically net borrowers while HH sectors are typically net lenders.
The OBR notes that, “since the start of the pandemic, business investment has been weak and recovered more slowly than other elements of expenditure.” In the 4Q21, business investment remained over 10% below its pre-pandemic peak and almost 3% below the OBR’s previous forecast. In its downward revision, the OBR expects, “investment not to recover to its pre-pandemic peak until the end of 2022 – nearly a year later than GDP as a whole”.
Trends and forecasts for RoW net borrowing as % GDP (Source: OBR; CMMP)
With both UK domestic sectors forecast to run simultaneous net deficits, the OBR assumes (by definition) that the ROW’s net surplus (ie, the UK’s current account deficit) will remain significant and of a similar size to the years before the pandemic. In other words, the UK will remain reliant on the RoW as a net lender. No change from previous forecasts there.
Conclusion
OBR forecasts from a sector balances perspective (Source: OBR; CMMP)
The OBR’s forecast that the UK’s budget deficit will fall to just over 1% GDP (£32bn) in 2026-27 will be welcome news for Rishi Sunak. This would represent the smallest budget deficit (£32bn) for 25 years.
Viewed from a sector balances perspective, these forecasts assume dramatic role reversals in the position of the UK government vis-à-vis the HH sector (and to lesser extent between the HH and NFC sectors) and sustained and significant current account deficits. The key risks to these forecasts lie in the assumption that, in the face of falling real incomes, HH will maintain consumption via reducing their savings ratio to a record low and/or by increasing their borrowing further (despite HH debt ratios).
Beyond the risks to key assumptions, there are two further problems with the OBR forecasts.
First, the assumed end-game envisages BOTH domestic sector running net deficits from 4Q22 onwards leaving the UK increasing reliant on the RoW as a net lender. Such a scenario appears neither attractive nor sustainable (see chart above).
Second, and more fundamentally, 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.
Faced with these two problems, I believe that the greatest value in these forecasts lies in the insights they provide into the key drivers and assumptions that lie behind current policy and thinking. From there, we can all form our own views as to the likelihood of them being achieved in reality…
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
The previous OBR forecasts viewed from a sector balances perspective (Source: OBR; CMMP)
The key message
The Office of Budget Responsibility (OBR) will publish its latest “Economic and fiscal outlook” tomorrow (Wednesday 23 March 2022) following the Chancellor’s Spring Statement in Parliament.
The outlook will present the OBR’s latest forecasts for the economy and public finances. The context remains one in which the Chancellor, Rishi Sunak, has pledged to restore order to the government finances after borrowing increased during the pandemic.
“The ongoing uncertainty caused by global shocks means it’s more important than ever to take a responsible approach to the public finances.”
Rishi Sunak quoted by Bloomberg (22 March 2022)
There are three key things to bear in mind when analysing these latest forecasts tomorrow:
Second, responsible fiscal outcomes are those that deliver a balanced economy not a balanced budget (see “Note to Rishi“)
Third, previous OBR forecasts for improvements in UK government finances (see key chart above) relied on unsustainable assumptions including sustained, twin domestic deficits counterbalanced by significant and persistent current account deficits (see “A return to abnormality“)
Rather than sending a message of fiscal responsibility, such assumptions smell more of “reverse engineering.” As always, one chart among the 200+ pages, will tell us all we need to know tomorrow…
Where are the “real risks” in French debt dynamics?
The key chart
Trends in French debt ($bn) broken down by sector (Source: BIS; CMMP)
The key message
France’s state auditor, the Cour des Comptes, “sounded the alarm” about the impact of pandemic spending on France’s widening budget deficit and rising government debt levels last week. The auditor also raised concerns about potential risks to the cohesion of the EA. Are these concerns justified or do greater risks lie elsewhere within French debt dynamics?
The auditor is correct to highlight the impact of pandemic spending on the government’s net borrowing. This rose from 78bn in 3Q19 to €220bn in 3Q21. The level of government debt and the debt ratio are close to their record 1Q21 highs. The debt ratio has remained above the EA’s 60% GDP threshold for the past two decades and the divergence in the debt ratios of France and Germany in the post-GFC period represents a “potential risk to the cohesion of the EA”.
The first counter argument, based on national accounting principles, is that the correct level of government net borrowing is the one that balances the economy not the budget. The level of private sector net lending rose from €75bn in 3Q19 to €225bn in 3Q21, driven largely by HH net savings of €134bn. In other words, the net borrowing of the government was a necessary, timely and appropriate response to the scale of the private sector’s net lending/disinvestment.
The second counter argument is that that while the outstanding stock of French government debt may be the fourth highest in the world, France ranks lower in terms of government indebtedness. This argument will be more compelling to those who view debt sustainability (correctly) as a flow concept, but much less compelling to those who prefer the traditional stock-based approach.
From a risk and financial stability perspective, we are more concerned about France’s private sector debt dynamics, particularly in the NFC sector. France has relatively high exposure to the NFC sector, the fifth most indebted NFC sector globally. In spite of this, France has seen the third highest rate of excess NFC credit growth globally over the past three years. Affordability risks in the NFC sector are also elevated in absolute terms and in relation to historic trends. While the level of HH indebtedness in France is low in absolute terms, the risks associated with excess HH credit growth and affordability are elevated in this sector too.
The headlines resulting from the Cour des Comptes’ report support our wider hypothesis that conventional macro thinking is flawed to the extent that it typically ignores private debt while seeing government debt as a problem rather than as a solution.
Sonnez l’alarme?
France’s state auditor, the Cour des Comptes, “sounded the alarm” about the impact of pandemic spending on the widening budget deficit and level of government debt in its 2022 Annual Report published on 16 February 2022. The auditor also argued that the government should revise its deficit reduction plans after April’s presidential election, claiming that current plans risk fuelling divergences within the euro area, especially with more fiscally conservative countries such as Germany.
The supporting evidence
Trend in government net borrowing over the past twenty years (Source: ECB; CMMP)
The state auditor is correct to highlight the impact of pandemic spending on the budget deficit. As illustrated in the chart above, the government’s net borrowing rose from €78bn in 3Q19 to €220bn in 3Q21. The current level of net borrowing is also higher than the previous peak net borrowing of €143bn in the aftermath of the GFC. Viewed in isolation, this is a scary chart!
Trends in government debt and debt ratios over the past twenty years (Source: BIS; CMMP)
The level of government debt and the debt ratio are also close to their all-time highs (see chart above). The outstanding stock of government debt rose form €2,727bn in 2Q19 to €3,088bn in 2Q21, slightly below the peak 1Q21 level of €3,099bn. The government debt ratio (the blue line above) rose from 113% GDP in 2Q19 to 128% GDP in 2Q21. Again, the debt ratio also peaked at 134% GDP in 1Q21. Note that throughout the past two decades, France’s government debt ratio has exceeded the EA’s threshold of 60% GDP.
Trends in French and German government debt ratios (Source: BIS; CMMP)
The debt ratios of France and Germany have been on different trajectories for most of the post-GFC period. The German government debt ratio peaked at 86% GDP in 4Q12 and declined to a recent low of 64% GDP in 4Q19 (still above the EA’s threshold level). So again, the auditor is correct to highlight this as a “potential” source of risk to the cohesion of the EA.
The counter arguments
The first counter argument here is a simple one – the correct level of government net borrowing is the one that balances the economy not the budget. It is a basic principle of national accounting that the net borrowing of one economic sector (in this case the French government), must be equal to net lending of one or other economic sector(s) (see “Everyone has one”).
Private sector net lending versus public sector net borrowing (Source: ECB; CMMP)
The chart above plots the net lending of the private sector and the net borrowing of the public sector together. The level of private sector net lending, or disinvestment (the blue area), rose from €75bn in 3Q19 to €225bn in 3Q21, driven largely by HH net savings of €134bn and FI net savings of €125bn.
In other words, the increase in the government’s net borrowing position essentially matched the increase in the private sector’s net lending position. Rather than a source of alarm, the spending response of the French government was necessary, timely and appropriate.
The second counter-argument is that while, the outstanding stock of French government debt may be the fourth highest in the world, France is ranked lower in terms of government indebtedness (with a debt ratio similar to the UK).
Top 10 BIS reporting economies ranked by total government debt (EURbn) (Source: BIS; CMMP)
The chart above ranks the top ten BIS reporting countries in terms of outstanding government debt. Total government debt was $3,670bn at the end of 2Q21, representing a 4% share of global government debt after the US (33%), Japan (14%) and the UK (5%). The chart below ranks the top ten BIS reporting countries in terms of the government debt ratio. In this case, France’s ranking drops to #8 globally and #7 in Europe after Greece, Italy, Portugal, Spain, Belgium and the UK.
Top 10 BIS reporting economies ranked by government debt ratio (% GDP) (Source: BIS; CMMP)
This second counter-argument will be less persuasive for those who view debt sustainability as a stock concept (the traditional approach). They will point to the fact that France’s government debt ratio is not only above the EA average, but it is also above the (largely arbitrarily chosen) 60% or 90% thresholds. CMMP analysis, which is centred on the sector balances framework, considers both fiscal space and debt sustainability as flow concepts and for reasons mentioned above (and possibly in future posts) is less concerned here.
What about private sector debt dynamics?
From a risk and financial stability perspective, we are more concerned about France’s private sector debt dynamics, particularly in the NFC sector.
Trends in the breakdown of French and EA debt (Source: BIS; CMMP)
France has a relatively high exposure to NFC debt. At the end of 2Q21, NFC debt accounted for 46% of total debt. This is down from 50% at the time of the GFC (see chart above) but remains above the aggregate shares of 32% and 39% for advanced and EA economies respectively. Why does this matter?
Top 10 BIS reporting economies ranked by NFC debt ratio (% GDP) (Source: BIS; CMMP)
France’s NFC sector is the fifth most indebted NFC sector among BIS economies. At the end of 2Q21, the NFC debt ratio was 170% GDP, after Luxembourg (322%), Hong Kong (304%), Sweden (179%) and Ireland (171%). The French NFC debt ratio is well above the 111% GDP and 98% GDP aggregate for all advanced and EA economies respectively and the 90% threshold level above which the BIS considers debt to be a drag on future growth.
In spite of the high level of NFC indebtedness, France has seen the third highest levels of excess NFC credit growth over the past three years (see chart above). The NFC sector’s RGF was 4.8% in 2Q21, after Switzerland (6.7%) and Japan (6.6%). The rate of excess NFC credit growth was well above the EA average of 1.8% and higher than the 3.0% average for all advanced economies. Risks are clearly elevated when excess rates of credit growth combine with high levels of indebtedness, as is the case here (for an explanation of the RGF framework see here.)
Trends in NFC debt service ratio (Source: BIS; CMMP)
The NFC debt service ratio (DSR) is also high in absolute terms and above its respective LT average despite the low absolute cost of NFC borrowing. As at the end of 2Q21, the DSR was 60%, 9ppt above its LT average of 51% (see chart above). France is one of four advanced economies where the DSRs are high in both absolute terms and in relation to LT averages, along with Sweden, Canada, and Norway (see chart below).
NFC debt service ratios and deviations from LT averages (Source: BIS; CMMP)
While the level of HH indebtedness in France is low in absolute and relative terms, the risks associated with excess HH credit growth and affordability are elevated in this sector too. At the end of 2Q21, the HH debt ratio was 67% GDP, slightly below the 4Q20 peak level of 68%. The HH debt ratio is higher than the 61% EA average but below the 77% advanced average and the BIS threshold level of 85% GDP. Nonetheless, France has the seen the highest rate of excess HH credit growth over the past three years among EA and other advanced economies. The HH’s debt service ratio, while low in absolute terms, is also above its LT average (see “Global debt dynamics – IV” for more details and charts).
Conclusion
The COVID-19 pandemic had a significant impact on the French government’s net borrowing and the level of government debt. The widening gap between France’s government debt ratio and those of the so-called “fiscally-conservative” economies is also a potential source of conflict with the EA. Viewed from a sector balances perspective, however, the government’s response was timely, necessary and appropriate. We are also more concerned about the risks associated with private sector debt dynamics, particularly in the highly indebted NFC sector.
More fundamentally, the headlines resulting from the Cour des Comptes’ report support our wider hypothesis that conventional macro thinking is flawed to the extent that it typically ignores private debt while seeing government debt as a problem rather than as a solution.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
UK and euro area (EA) money sectors have sent remarkably consistent messages throughout the COVID-pandemic. Shared trends in monetary aggregates, for example, provided similar conclusions regarding household (HH) behaviour, consumption and growth, the challenges facing policy makers, and the productivity of lending to the private sector (PSC).
The 4Q21 proved to be an important inflexion point in terms of HH confidence and behaviour in both regions. By December 2021, monthly deposit flows had moderated to 0.6x and 0.7x their pre-pandemic levels in the UK and EA respectively, leaving excess savings of c£162bn and c€285bn in the form of bank deposits. Demand for consumer credit recovered to 1.4% YoY and 1.2% YoY in the UK and EA respectively, and quarterly flows were positive in each of the past three quarters. So far, so good.
In addition to rising inflation, the Bank of England and the ECB both face on-going challenges in terms of the persistent desychronisation of money and credit cycles, which limits monetary policy effectiveness, and the fact that policy responses to date have fuelled growth in the wrong type of credit. The gap between the growth in money supply (ST liabilities of banks) and growth in PSC (key assets of banks) has narrowed but remains wide by historic standards. Nonetheless, the build-up of excess liquidity in both regions is slowing. Mortgage lending, the largest element of so-called “FIRE-based” lending, continues to be the main driver of PSC in the UK and the EA. This has potentially negative implications for growth, leverage, income inequality and financial stability.
In short, the money sectors in the UK and EA continue to sing from the same song sheet. The message for corporates, policy makers and investors alike is that an important inflexion point was reached in terms of HH confidence and behaviour in 4Q21. This is welcome news.
Of course, policy challenges remain and a slowdown in excess liquidity and/or a diversion into productive COCO-based lending rather than less productive FIRE-based lending may be less welcome news for financial assets in 2022.
The money sectors in the UK and the euro area (EA) have sent remarkably consistent messages throughout the COVID-19 pandemic. We know that narrow money (M1), and overnight deposits within M1, drove the expansion of broad money (M4ex, M3 respectively) in both regions during 2020, for example. In other words, the rise in broad money illustrated in the chart above was a reflection of the deflationary forces of increased savings and delayed consumption.
We also know that, as at the end of December 2021, M1 represented 68% and 73% of M3 in the UK and the EA, up from 48% and 51% respectively a decade earlier (see chart below). Preference for highly liquid assets remains high, despite the negative real returns earned from those assets.
Narrow money as a share of broad money since December 2011 (Source: BoE; ECB; CMMP)
A sustained recovery in both regions required/requires a reversal of these deflationary trends ie, a moderation in monthly HH deposit flows and a recovery in consumer credit (see “Three key charts for 2021”). Central banks also need to see a resynching of money and credit cycles. Why? Because, monetary policy effectiveness is based on certain stable relationships between monetary aggregates.
Monthly HH deposit flows as a multiple (x) of pre-pandemic levels (Source: BoE; ECB; CMMP)
As noted in “Missing the point?” in December 2021, HH behaviour reached a potentially important inflexion point at the start of the 4Q21. Monthly deposit flows (see chart above) peaked at 5.9x pre-pandemic levels in the UK in May 2020 and 2.4x pre-pandemic levels in the EA in April 2020. In December 2021, these flows had moderated to 0.6x and 0.7x pre-pandemic levels respectively. During this process HHs have accumulated excess savings in the form of bank deposits of £162bn in the UK and €285bn in the EA (CMMP estimates).
Annual growth rates in consumer credit reached a low point in February 2021 in both the UK (-10% YoY) and the EA (-3% YoY). In December 2021, however, annual growth rates had recovered to 1.4% YoY and 1.2% YoY respectively in the UK and EA respectively (see chart above). More importantly perhaps, quarterly flows of consumer credit have been positive and rising for the past three quarters (see chart below). The 4Q21 flows of £3bn and €4bn in the UK and EA respectively remain below pre-pandemic levels, however, especially in the EA where quarterly flows averaged €10bn during 2018-2019.
Quarterly flows in consumer credit (£bn, EURO bn) (Source: BoE; ECB; CMMP)
The COVID-19 pandemic exacerbated the desynchronisation of money and credit cycles in the UK and EA creating major challenges for policy makers, banks and investors alike. The degree of this desynchronisation peaked in early 2021 and reached its narrowest level since early 2020 in December 2021 (see chart below). That said, the gap between the growth rates of money supply (short-term liabilities of banks) and private sector lending (the main asset of banks) persists and remains high in a historic context.
Growth in lending (% YoY) minus growth in money supply (% YoY) (Source: BoE; ECB; CMMP)
Mortgage lending, the largest element of so-called “FIRE-based lending”, continues to be the main driver of PSC growth in both regions (see chart below). In December 2021, mortgage lending grew 5.1% YoY in the UK and 5.4% YoY in the EA. Lending to NFCs, the largest element of more productive “COCO-based lending”, rose 4.2% YoY in the EA but fell -0.4% YoY in the UK. As described above, consumer credit, another form of COCO-based lending grew 1.4% YoY and 1.2% YoY in the UK and EA respectively.
Breakdown on PSC growth by type of lending (% YoY) (Source: BoE; ECB; CMMP)
Conclusion
The money sectors in the UK and EA continue to sing from the same song sheet. The message for corporates, policy makers and investors alike is that an important inflexion point was reached in terms of HH confidence and behaviour in 4Q21. This is welcome news. Of course, policy challenges remain and a slowdown in excess liquidity and/or a diversion into productive COCO-based lending rather than less productive FIRE-based lending may be less welcome news for financial assets in 2022.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
HH behaviour is normalising but policy challenges remain in the euro area
The key chart
Monetary developments in the euro area since 1999 (Source: ECB; CMMP)
The key message
Broad money growth in the euro area (EA) slowed to 6.9% in December 2021, the slowest rate of growth since February 2020. What is the main driver here and what are the messages for household behaviour, growth, macro policy and the productiveness of lending?
Narrow money (9.8% YoY) continues to be the main driver of broad money growth, contributing 7ppt to the overall 6.9% growth. Overnight deposits (10.1% YoY) contributed 6.2ppt alone. Note (again) that money sitting idly in overnight deposits contributes to neither growth nor inflation. Explanations for rising inflation lie elsewhere.
The on-going moderation in monthly household (HH) deposit flows indicates reduced uncertainty and a normalisation of behaviour. While these flows rose from €17bn in November 2021 to €23bn in December 2021, they remain below the pre-pandemic average of €33bn.
HHs repaid €3.3bn in consumer credit in December 2021, the first net repayments since April 2021. That said, positive quarterly flows of consumer credit of €2bn, €4bn and €b4bn in 2Q21, 3Q21 and 4Q21 respectively also point to a steady normalisation in HH behaviour.
Money and credit cycles remain out-of-synch with each other, presenting an on-going challenge to policy makers. The degree of de-synchronisation reached its narrowest level since March 2020, however, an indication that the build-up of excess liquidity in the EA is slowing.
The additional challenge for policy makers is that less productive FIRE-based lending continues to be the main driver of PSC. This re-enforces the need for macroprudential polices to address rising financial stability risks in the residential real estate (RRE) sector.
In short, the message from the money sector at the end of 2021 and the start of 2022 is mixed. HH behaviour is normalising with deposit flows moderating and demand for consumer credit recovering. Against this, policy makers face the dual challenge of de-synchronised money and credit cycles and excess growth in less-productive FIRE-based lending. Four key signals to watch in 2022…
Slow and steady as she goes
Long-term trends in EA broad money (% YoY) (Source: ECB; CMMP)
Broad money (M3) growth in the euro area (EA) slowed from 7.4% YoY in November 2021 to 6.9% YoY in December 2022, the slowest rate of growth since February 2021 (see chart above). This post examines the current drivers of broad money growth and the implications for household behaviour, growth, macro policy and the productivity of lending in the EA.
Twenty year trends in M3 (% YoY) and contribution (ppt) from M1 (Source: ECB; CMMP)
Narrow money (M1) continues to be the key driver of broad money growth in the EA. M1 grew 9.8% YoY in December 2021 and contributed 7.0ppt to the overall 6.9% growth in broad money alone (see chart above). Within M1, overnight deposits grew 10.1% YoY and contributed 6.2ppt to M3 growth while currency in circulation grew 7.7% YoY and contributed 0.7ppt to M3 growth.
The key point here is that growth in overnight deposits has been the main driver of broad money growth during the COVID-19 pandemic. This matters because money sitting idly in bank deposits contributes to neither growth nor inflation. The causes of rising inflation lie elsewhere.
Trends in monthly HH deposits (EURbn) since January 2019 (Source: ECB; CMMP)
The on-going moderation in monthly household (HH) deposit flows indicates reduced uncertainty and a normalisation of HH behaviour. The sharp rise seen during Phase 2 of the pandemic (see chart above) was driven by a combination of forced and precautionary HH savings – that is, money that was not spent. At their peak of €78bn in April 2020, monthly flows were almost 2.5x their pre-pandemic levels.
In December 2021, monthly flows had fallen back to €23bn, up from €17bn in November 2021, but below the pre-pandemic average level of €33bn. Similarly, HH deposit flows for the 4Q21 were €59bn, down from €109bn and €93bn in the 3Q21 and 2Q21 respectively and below the average €99bn quarterly flows recorded during 2019.
Monthly flows (EUR bn) and growth rates (% YoY) in consumer credit (Source: ECB; CMMP)
HHs repaid €3.3bn in consumer credit in December 2021. This was the first net repayment since April 2021 (see chart above). That said, quarterly flows of consumer credit €2bn, €4bn and €b4bn in 2Q21, 3Q21 and 4Q21 respectively (see chart below) also point to a normalisation in HH behaviour.
Quarterly flows (EUR bn) in consumer credit (Source: ECB; CMMP)Trends in money and credit cycles in the euro area (Source: ECB; CMMP)
Money and credit cycles remain out-of-synch with each other, presenting an on-going challenge to policy makers. The gap between the YoY growth rate of PSC (4.7%) and the YoY growth rate in M3 (6.9%) was -2.8ppt in December 2021 (see chart above). While the degree of de-synchronisation has reached its narrowest level since March 2020, the challenge for policy makers remains since, “monetary policy effectiveness is based on certain stable relationships between monetary aggregates” (Richard Koo, The Holy Grail of Macroeconomics).
Trends in PSC (% YoY) in nominal and real terms (Source: ECB; CMMP)
Private sector credit (PSC) grew 3.9% YoY in nominal terms in December 2021 but fell -1.0% YoY in real terms (see chart above). The additional challenge for policy makers is that less productive FIRE-based lending continues to be the main driver of EA credit. FIRE-based lending contributed 2.5ppt to the overall 3.9% YoY growth rate in PSC in December 2022 (see chart below). Mortgages alone contributed 2.1ppt to this, re-enforcing the need for macroprudential polices to address rising financial stability risks in the residential real estate sector.
Trends in PSC (% YoY) and breakdown (ppt) between FIRE-based and COCO-based lending (Source: ECB; CMMP)
On a final positive note, the contribution of more productive COCO-based lending to overall PSC growth hit its highest level since March 2021 (see chart below), but all forms of COCO-based lending declined YoY in real terms.
Trends in PSC (% YoY) and contribution (ppt) of COCO-based lending (Source: ECB; CMMP)
Conclusion
In conclusion, the message from the money sector at the end of 2021 and the start of 2022 is mixed. HH behaviour is normalising with deposit flows moderating and demand for consumer credit recovering. Against this, policy makers face the dual, on-going challenge of de-synchronised money and credit cycles and excess growth in less-productive FIRE-based lending. Four key signals for 2022…
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Total debt ($bn) and debt ratios (% GDP) for EM’s five largest debt markets (Source: BIS; CMMP)
The key message
Following recent analysis of global and emerging market (EM) debt dynamics and in advance of the Indian government’s announcement of its annual budget on 1 February 2022, this post summarises seven key structural features of Indian debt dynamics.
India is the third largest EM debt market in terms of total, private sector (PSC), corporate (NFC), and household (HH) debt after China and Korea and ahead of Brazil and Russia. Beyond absolute size, the key features of Indian debt dynamics include:
PSC accounts for a relatively low share (51%) of total debt. In this context, India ranks #15 among our sample of 21 EM economies
In terms of the private versus public sector breakdown, India is similar to Brazil but very different to Russia, Korea and China
This matters because risks associated with elevated private sector debt are greater than those associated with public sector debt
While Indian debt markets are large in absolute terms, the level of indebtedness is relatively low. Both the NFC (55% GDP) and HH (36% GDP) debt ratios are below both EM averages and BIS threshold limits
Indian debt ratios are also relatively low in an historic context. HH indebtedness peaked at 43% GDP in 3Q07 while NFC indebtedness peaked at 71% GDP in 4Q12 (n.b. debt levels and levels of indebtedness are very different measures!)
India has experienced periods of elevated risks associated with excess credit growth in the (not-so-distant) past – first in the NFC sector (until 4Q14) and then in the HH sector (since 3Q19). Current risks are moderate, however, in both sectors with RGFs below recent peaks
Affordability risks in India are also relatively low in EM, global and historic contexts. India’s PS debt service ratio of 10% is well below its 10Y average of 13%
These features re-enforce the conclusion of “Global Debt Dynamics – V” that it is time to “replace the EM debt story with individual EM country debt stories.” Debt dynamics and their implications for policy, investment decisions and financial stability differ markedly even among EM’s five largest markets.
In short, India scores relatively well in terms of the risks associated with structure, indebtedness, growth and affordability of debt.
The India debt story
Size
Total debt ($bn) and debt ratios (% GDP) for EM’s five largest debt markets (Source: BIS; CMMP)
India is the third largest EM debt market in terms of total ($4,656bn), PSC ($2,550bn), NFC (£1,540bn) and HH debt ($1,011bn) after China and Korea and ahead of Brazil and Russia (see chart above).
Structure
PSC debt as % of total debt for EM’s five largest debt markets (Source: BIS; CMMP)
A key feature of the structure of Indian debt is the relatively low share of private sector debt (51% total). In this context, India ranks #15 among the 21 BIS EM reporting economies. In other words, the private versus public sector breakdown of India debt is similar to Brazil but very different to Russia, Korea, and China (see chart above).
This matters because risks associated with elevated private sector debt are greater than those associated with elevated public sector debt.
Indebtedness
HH and NFC debt ratios for EM economies (Source: BIS; CMMP)
While India is a large debt market in absolute terms, the level of indebtedness is relatively low in an EM context (see above). In terms of PSC (90% GDP), NFC (55% GDP) and HH (36% GDP) debt ratios, India ranks #11, #12, and #10 respectively. Both the NFC and HH debt ratios are below the EM averages (dotted blue line) and the BIS threshold limits (dotted red line).
Trends in Indian PSC, NFC and HH debt ratios (% GDP) (Source: BIS; CMMP)
Indian debt ratios are also relatively low in an historic context. The HH debt ratio of 36% GDP is 7ppt below the 43% GDP peak reached back in 3Q07. The NFC debt ratio of 55% GDP is 16ppt below the 71% GDP peak reached in 4Q12, the point at which the PSC debt ratio also peaked at 106% GDP (see graph above).
NFC snapshot
NFC sector snapshot (Source: BIS; CMMP)
At the end of 2Q21, the level of outstanding NFC debt was $1,540bn, $39bn below the peak level recorded in the previous quarter. As noted above, India is the third largest NFC debt market in absolute terms with a market share of 4%. In terms of NFC indebtedness, however, India ranks #12 among the EM universe. NFC’s share of total debt (31%) is also relatively low. In this context, India ranks #14 among the EM universe.
HH snapshot
HH sector snapshot (Source: BIS; CMMP)
The level of outstanding HH debt was $1,010bn at the end of 2Q21, again £26bn below the peak level recorded in the previous sector. India is the third largest HH debt market in our EM universe with a market share of 6%. In terms of indebtedness, however, India ranks #10 among our EM universe. HH debt represents a relatively low 20% of total debt. In this context, India ranks #12 among our EM universe. In other words, the HH and NFC sectors share a number of similar characteristics.
In terms of risks to macro policy, investment decisions and financial stability, the lesson from EM history is that the rate of excess credit growth can be as important as the level of indebtedness.
The risks associated with excess credit growth in India are relatively low in an EM context (see chart) above and in an historic context. The latest PSC RGF of 1.8% is lower than the EM average of 6.0% and the levels for China (2.3%), Korea (5.8%), Brazil (6.2%) and Russia (2.2%), countries with higher of similar (Brazil) PSC debt ratios.
Trends in HH, NFC and PSC relative growth factors (Source: BIS; CMMP)
In the post-GFC period, India has experienced periods of elevate growth risks, first in the NFC sector and then in the HH sector. Over the past five years, these risks have been concentrated in the HH sector but rose more recently in the NFC sector again (see chart above). Note however, the rates of excess growth rates have peaked in both cases (and remain modest in absolute terms).
Affordability
EM debt service ratios (x-axis) and deviations from LT average (y-axis) (Source: BIS; CMMP)
Affordability risks in India are also relatively low in an EM and global context and in an historic Indian context. The chart above plots the latest debt service ratios (DSR) for BIS reporting economies (x-axis) and the deviation of each DSR from its LT average. As can be seen India has a relatively low DSR of 9.8%, well below its 10-year average of 12.5% (see also chart below).
Trends in Indian PSC debt service ratio (Source: BIS; CMMP)
Conclusion
These features re-enforce the conclusion of “Global Debt Dynamics – V” that it is time to “replace the EM debt story with individual EM country debt stories.”
Financial stability heatmap for EM’s five largest debt markets (Source: BIS; CMMP)
Debt dynamics and their implications for policy, investment decisions and financial stability differ markedly even among EM’s five largest markets, for example (see the summary heatmap above).
In short, India scores relatively well in terms of risks associated with structure, indebtedness, growth and affordability of debt (n.b. the lack of red shading in the heatmap above in relation to India).
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Why does the changing nature of global debt matter?
The key chart
Changes in breakdown of global debt (% total) since the GFC (Source: BIS; CMMP)
The key message
“Private debt causes crises – public debt (to some extent) ends them.”
Professor Steve Keen, June 2021
While a great deal of attention is focused on the fact that global debt levels hit new highs during 2021, too little attention is given to the important changes that have taken place in the structure of global debt since the GFC.
This matters because conventional macro theory struggles to deal with the implications here, since it typically ignores private debt while seeing government debt as a problem rather than as a solution.
There has been an important shift away from household (HH) debt towards government debt at the aggregate, global level since the Global Financial Crisis (GFC). Debt dynamics in advanced economies have driven this shift, most notably in the US and the UK. In contrast, the structure of emerging economies’ (EMs) debt remains broadly unchanged, with a structural bias towards private sector debt. These trends matter for a number of reasons:
First, and in contrast conventional theory, we know that government deficits increase the supply of money (not the demand for money), crowd-in investment private spending (as opposed to crowding it out) and depress interest rates (rather than driving them up).
Second, and from this, we also know that while private sector debt typically causes crises, public sector debt typically limits their damage/ends them.
Third, the structure of US and UK debt is now the mirror image of the pre-GFC period, which reduces associated risks since governments face different financial constraints to HHs and NFCs and cannot, as currency issuers, become insolvent. Risks associated with excess credit growth exist more obviously in other advanced economies.
Fourth, EMs face very different risks to advanced economies. These are associated largely with the level of NFC debt, the growth rate in HH debt and the increasing dominance of China in EM debt.
Global debt dynamics – I
Debt dynamics since the GFC
In the “Seven lessons from the money sector in 2021”, I noted that our understanding of global debt dynamics is improved significantly by extending analysis beyond the level of debt to include its structure, growth and affordability.
In this first post of 2022, and the first in a series of five posts reviewing current global debt dynamics, I focus on the implications of the changes that have taken place in the structure of global debt since the Global Financial Crisis (GFC).
Global debt levels ($tr) and debt ratios (% GDP) as at end 2Q21 (Source: BIS; CMMP)
A great deal of attention has focused on the fact that global debt levels hit new, record highs in 2021 (see chart above). According to BIS statistics released on 6 December 2021, total debt (to the non-financial sector) reached $225tr at the end of 2Q21. NFC debt reached $86tr (38% total), government debt reached $83tr (37% total) and HH debt reached $55tr (25% total).
Note that while it is common to aggregate these three categories of debt together, it is also important to recognise that NFC and HH debt sit on the liabilities side of private sector balance sheets, while government debt sits on the assets side of private sector (and RoW) balance sheets.
Note also, that while debt levels are at record highs, debt ratios (ie, debt as a percentage of GDP) are below their 4Q20 peaks in each category.
Changes in breakdown of global debt (% total) since the GFC (Source: BIS; CMMP)
Too little attention has focused, however, on the important changes that have taken place to the structure of global debt since the GFC (see chart above). While NFC debt’s share of total debt has remained relatively stable at just under 40%, there has been an important shift away from HH debt to government debt over the period. HH debt’s share of total debt has fallen from 32% to 25% (see chart below). In contrast, government debt’s share of total debt has risen from 29% to 37%.
Trends in shares of HH and government debt (% total debt) since GFC (Source: BIS; CMMP)
Debt dynamics in advanced economies have driven this shift, most notably in the US and the UK (see chart below). In advanced economies, the US and the UK the share of HH debt has fallen from 34% to 26%, from 42% to 28% and from 43% to 30% respectively. In contrast, the respective shares of government debt to total debt have risen from 29% to 42%, from 26% to 44% and from 20% to 45% respectively. Similar shifts have also taken place in the EA, albeit in a much more muted fashion. This reflects a much lower (27%) share of HH debt at the time of the GFC in the EA.
Changes in structure of global debt by region (Source: BIS; CMMP)
The structure of EM debt remains broadly unchanged, however, with a bias towards private sector debt. At the end of 2Q21, the shares of HH, NFC and government debt to total debt in EM were 22%, 50% and 28% respectively.
Trends in structure (% total) of EM debt since GFC (Source: BIS; CMMP)
Note that China’s share of total EM debt has risen from 31% to 64% over the period. In other words, the EM debt story is increasingly a “China debt” story. For reference, China’s share of total global debt has also increased from 5% to 21% over the same period (see chart below). In contrast, EM excluding China’s share of total global debt has remain unchanged.
Trends in EM share of global debt since GFC (Source: BIS; CMMP)
Why does this matter?
This matters for a number of reasons. First, and in contrast conventional theory, we know that government deficits increase the supply of money (not the demand for money), crowd-in investment private spending (as opposed to crowding it out) and depress interest rates (rather than driving them up).
Professor Steve Keen has written extensively on this subject. He notes that, “rather than deficits meaning that the government has to take money away from the private sector – which is what the mainstream thinks the government does when it sells bonds to cover the deficit – the deficit creates money by increasing the bank deposits of the private sector”. In simple terms, by not studying the accounting involved in government deficits, Keen argues that they (mainstream economists) have wrongly classified them as increasing the demand for money, when in fact they increase the supply of money. I agree.
The implication here is that many arguments regarding global debt are in fact, back-to-front. Government deficits crowd in private spending and investment by increasing the supply of money. They also typically drive down interest rates rather than driving them up.
Second, and from this, we also know that while private sector debt typically causes crises, public sector debt typically limits their damage/ends them. Consider the EA’s fiscal rules that put limits on government debt and deficits but completely ignored private debt and credit and the history of Spanish debt dynamics after the introduction of the euro (see chart below).
Ignore excess private sector debt growth at your peril I – Spain (Source: BIS; CMMP)
After the introduction of the euro, government debt in Spain fell from 70% to 36% in March 2008. In contrast, private sector debt rose from 80% of GDP to 208% of GDP over the same period before peaking at 227% in 2Q10 at the height of the Spanish banking crisis (see chart above). Similar trends were also seen in other advanced economies. The chart below illustrates trends in private sector credit and government debt in the US.
Ignore excess private sector growth at your peril II – the US (Source: BIS; CMMP)
Excess growth in private sector debt up to a crisis point is followed by increases in government debt post-crisis in response to the collapse in demand as credit growth turns negative and the private sector reduces leverage. In short, recent history supports Professor Keen’s hypothesis that private debt causes crisis, while public debt ends them (or limits their damage). This topic and these case studies are developed in more detail in other posts/CMMP research.
Shift from US and UK HH debt to government debt (% total debt) since GFC (Source: BIS; CMMP)
Third, the structure of US and UK debt is now the mirror image of the pre-GFC period (see chart above). This reduces associated risks since governments face different financial constraints to HHs and NFCs and cannot, as currency issuers, become insolvent.
Rates of excess credit growth in EM (Source: CMMP)
Fourth, EMs face very different risks to advanced economies. These are associated largely with the level of NFC debt, the growth rate in HH debt (see chart above) and the increasing dominance of China in EM debt – subjects that I will address in the final post in this series.
Conclusion
Global debt dynamics are a core element of CMMP analysis. While it is natural to focus initially on the new highs in global debt levels, it is also important not to miss the important messages associated with changes in the structure, growth and affordability of global debt.
The shift in the structure of global debt from HH debt to government debt has important implications for the severity of recessions, monetary dynamics, inflation, rates and investment risks. The nature of these implications also vary depending on whether governments are currency issuers (eg, US and UK) or currency users (eg, EA governments). The risks of a return to pre-pandemic policy mixes remain in all areas, however.
In the next post, I will examine dynamics in global private sector debt.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
