UK set for a decade of deleveraging

Allister Heath
WELCOME to modern Britain, a nation of over-leveraged debt junkies only just waking up to the urgency of mending its ways. Realising the scale of the UK’s long-standing addiction to credit is vital to understanding why growth forecasts are being cut left, right and centre.

The real drag on demand in the UK won’t come from cuts to government spending – in the aggregate, these will be worth just 0.7 per cent this year and around half that in terms of spending as a share of GDP. There will be lots of pressure from elevated inflation eroding the value of wages and savings – the pound has last 5.5 per cent of its buying power over the past year alone. But the biggest drag of all will come from the private sector’s belated realisation that it must slowly but surely tackle its imprudently high levels of debt. This is a good thing – but like for a chastened patient weaning himself from an addiction to crack, the transition process for UK Plc will be debilitatingly painful.

Households and non-financial companies’ total borrowing as a share of national income has so far declined only very modestly. Their combined debt peaked at a ridiculously high 231 per cent of GDP in the fourth quarter of 2008, before falling back to 211 per cent by the second quarter of this year, according to an analysis of the figures from Citigroup. At this rate (around 8 per cent of GDP per year), the great private sector deleveraging journey will take another decade. Private debt needs to stabilise at a level compatible with much higher interest rates (as these are bound eventually to rise) and far lower house prices (these are already down 20-30 per cent in real terms in the UK as a whole, with prime central London the only remaining island of buoyancy).

A decade of deleveraging means ten years of reduced private sector demand; it means ten years of weak growth for retailers, restaurants and others dependent on consumer spending. It also means that unless the return on investment by companies increases thanks to supply-side reforms, or export markets expand dramatically, the UK’s trend economic growth rate will probably stay stuck at about 1.5 per cent a year. This will not be enough for the Chancellor to meet his borrowing forecasts and will therefore either force even greater austerity or trigger a major crisis.

So far, corporate debt has dropped from 122 per cent of GDP in late 2008 to 108 per cent today. Household debt is down from 111 per cent at the start of 2009 to 103 per cent today. Depressingly, however, virtually all the gains made by the private sector have been cancelled out by our still profligate public sector, which will add around £120bn to the national debt this year alone. Private debt (excluding financial firms) plus public debt is now equivalent to 291 per cent of GDP, down only trivially from the 294 per cent at which it peaked in the third quarter of 2009. It was 194 per cent 10 years ago and 172 per cent 20 years ago. We remain roughly at the level Japan reached during its darkest hour 15 or so years ago.

The UK’s total debt level is the third highest in the EU: roughly the same as Greece’s (prior to the haircuts being proposed). Only Portugal and Ireland have higher amounts of debt. There is no choice: Britain must deleverage. Gordon Brown’s time in office will eventually be remembered as the years Britain borrowed itself to the brink of disaster.
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