A worse financial crisis on the way as families need to tighten their belts till 2020
There’s a worse crisis on the way unless we get serious about tackling debt
For all of the talk of austerity, Britain is still drowning in debt, private as well as public.
A reveller wears a Union Jack whilst walking along side the Thames
Allister Heath By Allister Heath6:27PM BST 04 Jun 2013Comments114 Comments
Families and companies have only just started down the long road towards fiscal responsibility, with the belt-tightening likely to continue until the end of the decade; and the public sector is still adding more to the national debt pile every week than the private sector is repaying.
We still aren’t remotely living within our means and – for all the genuine pain in some quarters – still haven’t made a decisive break with the irrational exuberance of the 2000s and the cultural delusions that accompanied it.
The political establishment remains unwilling to admit to itself, let alone to the public, that the welfare state is going to have to be massively pared down, and that individuals will need to consume less and save more.
Instead, it’s still largely business as usual in Westminster: George Osborne’s plans to subsidise another credit-fuelled housing bubble are terrifyingly reckless, and Ed Balls’ policy to cut pensioner benefits amounts to £105m a year, saving 0.01pc of the £720bn in government spending.
There has been some progress, of course, but it remains too limited. Household debt has fallen from 111pc of GDP at the start of 2009 to 99pc at the end of last year, according to official data analysed in a recent note by Michael Saunders, Citigroup’s brilliant economist. For private firms excluding banks, debt has dropped from 121pc of GDP to 108pc.
This is a decent readjustment, with individuals and businesses trying to put themselves on firmer footings – and helps to explain why banks’ net lending remains relentlessly negative – but this process has much further to go.
Together, families and non-financial firms’ debt is still worth 208pc of GDP and is merely back to levels last seen in mid-2007, a time when leverage was already utterly unsustainable. Current debt levels remain much higher than they were a decade ago (170pc of GDP) and 15 years ago (128pc of GDP).
Nobody knows what the “right”, sustainable level of private sector debt is, and it depends crucially on expected productivity, wage and jobs growth, as well as on inflation, but it is certainly far lower than today’s levels.
A fair bet is that the private sector’s debt to GDP ratio will have to fall back by another 50 percentage points or so; even if nominal GDP grows by a highly optimistic 4pc to 5pc a year over the next few years, net borrowing will also have to fall every year until 2020.
Debtors will actually have to repay loans, not merely assume that a growing economy will bail them out. This will depress consumer spending as well as corporate investment, unless the rise in the stock market continues, unlocking alternative sources of finance for companies. Inflation won’t bail us out: with private sector wage growth now almost zero, higher prices reduce household incomes just as much as they cut their debt, making no real difference.
Anybody who believes that private sector debt has ceased to be a problem should stress-test their own finances. Could you cope if the base rate rose to 5pc, from today’s 0.5pc. Or 8pc? Or 10pc? Even if you could survive, could others? Could your employers? If not, that means that the debt burden needs to be lower.
The current, extraordinarily low levels of Bank interest rates, combined with quantitative easing and subsidies for credit, are an aberration. At some point, they will be replaced by more normal conditions, something for which millions of households are still not ready.
Shockingly, even after the recent repayments and write-offs, the combined debt of families and non-financial firms remains 82pc of GDP higher than they were at the start of 1997, just before Gordon Brown became Chancellor.
By contrast, as the Citigroup research paper points out, America’s private debt burden rose by a more reasonable 39pc of GDP during that time, helped by massive deleveraging and write-offs in recent years, and even the eurozone’s 58pc of GDP increase is lower than ours. Forget the US sub-prime crisis or the euro bubble: we were the real debt junkies, and will continue to pay the price for our stupidity and the previous government’s incompetence for years to come.
Only Greece, Cyprus, the Netherlands, Portugal and Cyprus currently have more private debt (as ever, excluding the banking system) than us, a horrible reality which shows that the British should not mock the woes of mismanaged, peripheral eurozone nations.
We would have gone bust and had to beg for a bail-out had we joined the single currency and been unable to rely on quantitative easing. The UK economy continues to rest on the bed of nitroglycerine first identified by Bill Gross, the US investor, in 2010.
It gets worse. The Government has increased its own debt burden so much that this has more than compensated for the deleveraging by families and private firms. General government debt has reached 90pc of GDP, up from 43.5pc when the crisis erupted in mid-2007.
Combined UK private and public debt (as ever, excluding the balance sheets of City banks) therefore reached a recent record of 298pc of GDP at the end of last year, higher than the eurozone average of 268pc.
Total debt levels only rose moderately in the UK between 1987 and 1997, increasing from 144pc of GDP to 178pc of GDP. They then started to shoot up, hitting 207pc of GDP five years later and 253pc at the start of the crisis. When Ed Balls insists, as he did this week, that the last Labour government didn’t spend too much and didn’t push the national debt too high, he is focusing exclusively on the government’s official, on-balance sheet national debt prior to the crisis.
But Gordon Brown fostered an unsustainable private sector credit bubble, grabbing a large chunk of the proceeds as tax. When the music stopped, the economy collapsed and the public finances were left with a gaping hole.
Osborne’s unbelievably silly plan to engineer his own neo-Brownite mortgage boom, combined with hugely overpriced housing, may temporarily halt the private sector’s deleveraging. This would give the Government a short-term boost, bolster consumer spending, buy some “growth” and help the Tory party’s election hopes, but would store up even greater problems for the future.
At some stage, the bond markets will pop, house prices will plunge, another large economy will implode, the cost of borrowing will soar and we will suffer another recession. At the moment, neither the private nor the public sector would be able to cope.
Unless we become serious about tackling private and public debt, the next crisis, when it eventually comes, will be unimaginably devastating.
Allister Heath is editor of City A.M.