America overcomes the debt crisis

Britain sinks deeper into the swamp

Britain has sunk deeper into debt. Three years after bubble burst, the UK has barely begun to tackle the crushing burden left by Gordon Brown. The contrast with the United States is frankly shocking.

As recently as 1990 Britain’s debts were still just 220pc of GDP. 

The latest report on "Debt and Deleveraging" by the McKinsey Global Institute shows that total public and private debt in the UK is still hovering at an all-time high. It has risen from 487pc to 507pc of GDP since the crisis began.

As the chart above shows, as recently as 1990 Britain’s debts were still just 220pc of GDP. Has a rich country ever been debauched so fast in peace time?

The ordeal of belt-tightening will be grim, dragging out for a generation if Japan is any guide. The Japanese at least began their post-bubble debacle as the world’s top creditor nation with a trade super-surplus and a savings rate of 17pc. Britain has no such buffers.

It is a very different picture in the US where light is emerging at the end of the tunnel. American banks, firms, and households have been chipping away at their debts, more than offsetting Washington’s double-digit deficits.

The total burden has dropped to 279pc, down from 295pc at the peak of the boom. Households have purged roughly a third of the excess, roughly tracking the historic pattern of post-bubble deleveraging.

US debt is already lower than Spain (363pc), France (346pc), or Italy (314pc), and may undercut Germany (278pc) before long -- given the refusal of the European Central Bank to offset fiscal contraction with monetary stimulus.

One is tempted to ask what all the fuss was about in the US. The debt of financial institutions is just 40pc, compared to the UK (219pc), Japan (120pc), France (97pc), Germany (87pc) and Italy (76pc). Bank debt has dropped from $8 trillion to $6.1 trillion -- accelerated by the Lehman collapse -- as lenders rely more on old-fashioned deposits.

Tim Congdon from International Monetary Research said US banks were never as damaged as claimed and now have the highest capital ratios in over thirty years. The rate of loan write-offs has dropped from 3.2pc to 1.9pc, a faster improvement than after the financial crisis of the early 1990s.

"There has to be a prospect that Fed funds rate will move back to a more normal level – say, 2pc to 4pc - over the next couple of years," he said. If so, this will come as an almighty shock to the bond and currency markets. Almost nobdy is prepared for such a turn of events.

In hindsight, the US property boom was was remarkable modest compared to what happened in Spain, or what is happening now in China now where the house price to income ratio in Beijing, Shanghai, and Shenzhen is near 18. America’s ratio peaked at 5.1 and is already back to its modern era average of three. The excesses have been unwound.

Personally, I am coming to the conclusion that the US crisis in 2008-2009 was largely a case of botched monetary policy and could easily have been avoided. The growth of M3 money -- which the Fed stopped tracking thanks to a young Ben Bernanke -- was allowed to balloon in the bubble, then collapse in 2008.

Europe’s crisis is more intractable, with far greater levels of bank leverage and vast intra-EMU trade imbalances. But botched monetary policy is a big part of the story there too. The ECB let M3 growth overheat, then let it crash in 2008, then crash again late last year, dooming Club Med to Sisyphean torture and certain asphyxiation.

Be that as it may, the McKinsey study said Britain’s household debt has dropped slightly from 103pc to 98pc since the crisis began. This is not nearly enough to offset the jump in government debt from 53pc to 81pc. "At the recent pace of debt reduction, we calculate that the ratio of UK household debt to disposable income would not return to its pre-bubble trend for up to a decade," it said.

A chunk of US deleveraging has been achieved by homeowners throwing in the keys and defaulting, as they can do in most US states without facing seizure of other assets. It is a crude way to clear debt but at least it brings matters to a head swiftly. Britain has disguised the problem instead, preventing foreclosures from running their course. Some 12pc of all UK mortgages are in "forbearance".

Britain’s property market is of course sui generis. We don’t build homes because of planning laws -- which is to say that the system is rigged in favour of `haves' against `have nots', with destructive social consquences. Construction was just 3.5pc of GDP during the boom, compared to 6pc in Germany and France, and 12pc in Spain (where there is an overhang of 1.5m unsold homes), or 13pc in China today. Given the chronic property shortage, prices cannot fall much.

Monthly debt payments are a third higher than in the US as a share on incomes, a remarkable fact given that two-thirds of UK mortgages are floating and base rates are near zero. What happens when they rise? Some 23pc of UK households report that they are already ‘somewhat’ or ‘heavily’ burdened in paying off debt.

Mckinsey adds financial sector debt to the total figures, explaining why Britain looks so awful. You could say that this is to mix up apples and oranges, since banks have assets to match their liabilities, but notice the nasty little kicker in the chart below (scroll along the charts above to see a larger version).

Britain’s banks have $359bn of exposure to the private debt of the GIIPS quintet of Greece, Ireland, Portugal, Spain, and Italy. If correct, this greater than German exposure (sovereign debt is another story). This is no longer theoretical. Defaults are escalating fast.

Yet even if banks are excluded, Britain still has debts of 288pc, the highest level of any major country after Japan. It is a mystery to me how Britain has kept its AAA rating.

Much trouble could have been avoided if Labour had stuck to two simple rules: a budget surplus late in the cycle (instead of 3pc deficits) as achieved in Scandinavia and even by Spain, and loan-to-value limit on mortgages of 80pc (instead of 120pc) -- ideally falling to 70pc, or even 60pc if needed to choke a boom, as pursued in East Asia.

Such a mix would have curbed the worst excesses, even in the context of a global credit bubble beyond British control -- which was caused by $10 trillion of reserve accumulation by China, rising Asia, and the petro-powers, and by negative real interest rates in the US and Europe.

We would never have reached the point where British households were extracting 4pc of GDP each year from homes in equity withdrawal, the crowning idiocy of Brownism.

At least we still have a sovereign currency to deal with the awful consequences. Sterling’s 15pc drop has saved a host of exporters while the Bank of England has spared us the agony of debt-deflation by launching quantitative worth 19pc of GDP, the biggest blitz ever by a modern central bank.

Had we surrendered our policy instruments, we would now be in the grip of full-blown depression like Greece, Ireland, Portugal, and Spain, each facing and peak-to-trough contractions of 10pc or even 20pc without any means of softening the blow, and some facing unemployment above 1930s levels.

For that great mercy we can thank Gordon. All is forgiven.

Brophy Sunday 22 January 2012 - 9:07 pm | | Brophy Blog

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