Debt Britannia

Dec31
by Steve Keen on December 31, 2011 at 11:28 am

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As much as I criticize the US of A for its economic management, I can’t fault its statistical agencies on the collection and dissemination of data: data is readily available and almost always in an easily accessible format. That, and the fact that it’s the world’s biggest economy, is why most of my analysis is of the US. Australia’s ABS deserves similar accolades for making data readily accessible and relatively easy to locate.

The UK data source, the Office of National Statistics, is almost impenetrable by comparison—it’s the statistical system that Sir Humphrey Appleby would design. It gives the appearance of accessibility, yet either drowns you in so much data in response to any query that you give up, or which, when you get to what you think you want, returns rubbish.

For example, you’d think following the sequence “Economy—UK Sector Accounts—Financial Assets and Liabilities” would actually take you to something resembling the USA’s Flow of Funds, wouldn’t you?

Guess again. Figure 1 shows what it returns you: no data, no publications, but links to four methodology papers on Investment Trusts. “Well done, Bernard!”

Figure 1

Given this state of affairs (or these affairs of state?), I haven’t bothered trying to put together a debt profile of the UK as I have for Australia and the USA—which of course shows the success of the Appleby method. But as so often happens, the method backfired when Morgan Stanley, using rather more research resources than I can bring to bear, published a chart of national indebtedness in which the UK was right at the top—with a staggering 950% private debt to GDP ratio, and a financial sector debt ratio alone of over 600%.

Figure 2: Morgan Stanley global debt ratio calculations

I expect that Sir Humphrey’s descendants are now busy putting out this brush fire with claims of double-counting, but even the UK Treasury’s Budget Report admits to a peak private sector debt to GDP ratio of over 450 percent, with the finance sector ratio alone being 250%:

“Over the pre-crisis decade, developments in the UK economy were driven by unsustainable levels of private sector debt and rising public sector debt. Indeed, it has been estimated that the UK became the most indebted country in the world.

Chart 1.1 highlights the rise in private sector debt in the UK. Households took on rising levels of mortgage debt to buy increasingly expensive housing, while by 2008 the debt of nonfinancial companies reached 110 per cent of GDP. Within the financial sector, the accumulation of debt was even greater. By 2007, the UK financial system had become the most highly leveraged of any major economy…” (UK Budget Report, 2011)

Figure 3: UK Treasury private debt to GDP figures

To put this into perspective, the USA’s private debt to GDP ratio peaked at 303% of GDP, and the rapid decline in this debt to its current level is what has caused its “Great Recession”. I never thought that another developed economy could make the USA’s debt bubble look trivial, but clearly I was wrong.

Figure 4: And you thought America had a debt bubble…

As well as aggregate UK private debt exceeding America’s, the UK also has a higher debt to GDP ratio for every sector. However as usual, government debt, about which politicians and neoclassical economists obsess, is the smallest component of total debt, and has only started to grow after the crisis began. To emphasise one point on which I emphatically agree with MMT economists, public debt is not the problem, and attempting to reduce public debt now is the wrong policy—from my perspective, because it would add public sector deleveraging to private sector deleveraging, thus exacerbating the underlying problem of deleveraging. Rather than obsessing about public debt now, politicians and economists should have been concerned about rising private debt in the previous two decades.

UK household debt grew along similar lines to USA household debt, but continued growing as US household debt started to taper. It is now falling, but still exceeds even Australia’s household debt ratio—though Australia holds the dubious record for the fastest rate of growth of household debt since 1990.

Figure 5

While UK households were relative laggards in the rate of growth of debt, UK businesses showed how it was done by tripling their indebtedness in just over 2 decades, from the post-1987 Stock Market Crash level of 38% of GDP to a whopping 118% at the end of 2009.

Figure 6

But “Cardboard Box? You were lucky!”. The Four Yorkshireman award for digging a hole faster than anybody else goes to the UK finance sector. The USA and UK both began the post-1987 Stock Market era with roughly comparable levels of finance sector debt—roughly 50% for the UK and 40% for the USA. But two decades later, UK finance sector debt peaked at 261% of GDP, more than twice the US level of 123% (I can’t show Australia’s finance sector debt since the RBA doesn’t separately record it, but the Morgan Stanley data in Figure 2 implies that it’s larger than America’s).

Figure 7

The combination makes the UK the Private Debt Capital of the G20 world.

Figure 8

All this implies that when a debt slowdown hits the UK, it could do so with even more impact than it did in the USA. As I’ve argued extensively elsewhere, aggregate demand in a credit-based economy is income plus the change in debt. This perspective puts the UK’s staggering dependence upon private debt into sharp relief; explains why—as yet—it hasn’t suffered as sharp a downturn as has the USA; and also implies that that day of reckoning may be approaching. Take a good look at Figure 9 and Figure 10.

Figure 9: British Aggregate Demand

Figure 10: American Aggregate Demand

Firstly, note that the peak debt contribution to aggregate demand was far higher in the UK than the USA: in 2008, the UK GDP was roughly 1.4 trillion pounds while the increase in debt was 800 billion, yielding total private sector spending (on assets as well as goods and services) of over 2.2 trillion; the US numbers are roughly 14 trillion dollars for GDP and 4 trillion for the increase in debt.

Secondly, the USA went straight from leveraging to deleveraging, with the change in debt going from adding $4 trillion in 2008 to subtracting 2.5 trillion in 2010. In the UK, there have been 4 dips into deleveraging, but 3 of them have subsequently been reversed, and the worst to date (in 2010) reduced aggregate demand by only 100 billion—40% of the impact of the peak decline in the USA.

But thirdly, another period of deleveraging has just begun in the UK, whereas the rate of decline of debt has slowed in the USA. Things aren’t looking rosy for 2012 in the USA, but they could be far worse in the UK.

Figure 11 compares debt-financed demand in the two countries: the UK’s debt binge has been strikingly larger, far more volatile, and is now headed down while the USA—though still deleveraging—is headed up.

Figure 11

The role of debt in driving both employment and asset prices is very apparent. The boom years of the UK economy from 1993 till 2008 were in fact its borrow years.

Figure 12

I prefer to correlate the Credit Accelerator to change in asset prices, but these next two figures are useful in showing the level of UK asset prices, as well as their correlation with the change in private debt.

Figure 13


 

Figure 14

The UK Credit Accelerator

As explained elsewhere (“A much more nebulous conception“), since the change in private debt is an important component of aggregate demand, and aggregate demand is expended on both commodities and assets, the acceleration of private debt will be correlated to the change in unemployment and the change in asset prices. This is very apparent in the UK data, and all 3 measures—unemployment, the FTSE and real house prices—are now under the influence of negative credit accelerators.

Figure 15

Figure 16

Figure 17

Add to this private sector deleveraging a government committed to a deluded program of “expansionary fiscal consolidation“, and the indications are that the UK will be a leader in the global recession stakes in 2012.