BRITAIN’S economic debate has moved on. A year ago, commentators were obsessed with whether austerity was good or bad for growth; today, with GDP roaring ahead, the big divide is between those who believe that the UK’s economic recovery is unbalanced and those who believe it will eventually turn out to be just fine.
One area where passions are running especially high – such things are, needless to say, relative – is whether or not this is a debt-fuelled recovery. The government and many independent economists believe that it isn’t; yet many critics worry that we haven’t learnt the lessons of the past and that we are laying the seeds for another debt-fuelled boom and bust of the sort contemporary Britain seems to specialise in.
On the face of it, despite the government’s wrongheaded subsidies for credit and home-buying, the overall increase in net private sector debt doesn’t seem to have become problematic yet, partly because many older home owners have been paying off mortgages faster than younger ones have been able to jump into the turbo-charged housing market.
But I fear that such a view misses the point. Not enough of the debt that UK households accumulated during the bubble has been liquidated or paid off; the overhang remains far too large for comfort. As a result, Britain is entering the next cycle with too much debt; we failed to deleverage sufficiently over the past five years.
Michael Saunders of Citigroup, one of the City’s most interesting economists, has compiled some fascinating debt data in his latest note. But while his statistics are spot on, we differ on their interpretation. Saunders is now very upbeat about the recovery’s sustainability; I remain terribly nervous.
The household debt to income ratio fell to 138 per cent in the third quarter of last year, the last period for which data is available, taking it back down to where it was in 2003.
That ratio was still at 142 per cent a year ago and hit an absurd peak of 170 per cent in the first quarter of 2008. Yet while this decline is to be welcome, it hasn’t gone far enough. Nobody knows what the “right” level of debt should be but I am pretty certain that it is much lower than it is today: we should probably be returning to the sorts of levels last seen in the 1990s.
Even if leverage on this measure falls a little further in the short term it will merely be a question of time before the ratio stabilises and then starts to increase again. The huge rise in mortgages (up 29 per cent year on year in December, for example) has much further to go, with housing transactions still relatively low. Sooner rather than later, as the recovery continues, net credit growth will begin to grow faster than income and GDP, and debt levels will start to creep up again. A cycle has come and gone; the debt peak was too high but so was the trough.
I have similar concerns when it comes to broader measures of leverage. The overall private sector debt/GDP ratio (the gross unconsolidated debts of household and non-financial firms) has fallen from a bonkers record of 218 per cent of GDP in the first quarter of 2009 to 185 per cent of GDP in the third quarter, according to Citigroup. Here too there is no cause for declaring victory against our culture of excess leverage. On the plus side, private debt (again excluding financial firms) fell by eight percentage points of GDP in the year to the third quarter of 2013. The scale of this decline means that for the first time in ages the UK’s overall debt – public and private non-financial– is down slightly as a share of GDP. Pension fund deficits have also shrunk, reducing further an off balance sheet measure of total UK debt.
But despite this genuine, incontrovertible progress, Britain’s households and government remain far too indebted for comfort. Does anybody really think that all will be fine when interest rates start to rise again? I hope I’m wrong, but I fear the worst.