Household debt in the UK recently hit a record high, surpassing the previous peak reached in September 2008. That was the month when Lehman Brothers collapsed, sparking off the global financial crisis. This time round, although it’s helping economic revival in the short term, rising personal debt could be destined for another “correction” which the government doesn’t seem able or motivated to fix.
Continued growth in UK household borrowing is the only way to get people spending again, when real incomes remain stagnant after a long fall. But our level of household debt invites an unflattering comparison with US economic policy, and shows up a persistent problem that could undermine our recovery.
US household debt peaked at just below 100% of GDP in early 2009, and has since fallen sharply, dropping below 80% by late 2012. This year’s continued fall, to pre-recession levels, enabled one official to declare “de-leveraging” complete.
Americans have reversed the heavy private borrowing that amplified growth before the “credit crunch”, and then worsened the downturn that followed. Total US debt –- adding households’ debt to that of corporations and government –- is relatively modest, at around 350% of GDP.
By contrast, in the UK household debt alone has stayed stubbornly at the 200% of GDP that it reached in 2007. As well as adding to their debts, British households have run down) their savings, withdrawing £23 billion in the past year. Total debt remains around 500% of GDP.
Private problems
High private debt is not inherently bad as long as it is more than matched by private assets, and that is largely the case here. Business debts are secured against plants and equipment that are unusually profitable in the UK, and almost 90% of household debt is secured against housing.
Yes, rising living costs and falling incomes have forced many UK households into borrowing at high interest rates from “payday” and other emergency lenders. But for the rest, taking on new debt was simply a logical response to record low interest rates, ensured by “quantitative easing”. When saving is pointless and money is cheap, why wouldn’t you get into more debt?
However, when combined with rising government debt, the continued refusal of household debts to fall poses both political and economic problems for the Chancellor.
Economically, it suggests that low interest rates have boosted the wrong parts of the private sector: cheaper money has funded household borrowing for property investment, rather than business borrowing for productive investment.
Buying houses may add to individual wealth, but it does little to boost overall national income. In fact, increased home ownership may even constrain growth as rising accommodation costs limit labour mobility.
Some recovery in house prices was needed to raise highly indebted home-buyers out of negative equity and get them spending again. But the economy is not yet “rebalancing”; property investment is still picking up while business investment keeps falling (down almost 4% from last year).
Politically, households’ and businesses’ refusal to lower debt is a potential embarrassment as the government has not been doing it either. The deficit may be narrowing, but until it is closed, public debt will keep growing. It is already at 90% of GDP and could climb to 100%.
On the basis that we’re “all in this together”, the coalition believed early action to curb government borrowing would help households do likewise. Instead, public and private debts are now rising simultaneously, pushing the UK towards a total debt matched only by Japan.
This makes for a fragile recovery. The IMF foresees US growth accelerating next year, while the UK’s stays well below trend.
Could have been us
The comparison with the US will hurt the Chancellor. The Obama administration took over after an equally bad housing and stock-market crash, with proportionally more American households on irredeemable “sub-prime” mortgages. But Obama deliberately raised public borrowing, with large “stimulus” spending on infrastructure, to deliver a swift return to overall growth. Without this growth household incomes can’t rise, and private debts can’t be repaid.
A quicker and stronger recovery has accordingly brought down American household debt: despite fluctuations, it is still US$1.4 trillion dollars lower than its 2008 high.
The two-year interruption to UK growth in 2011-12, soon to be forgotten amid the pre-election recovery, could return to haunt whoever is elected in 2015. Growth first stopped in 2008 because a fall in house prices undermined households’ ability to repay loans, and banks’ ability to go on making them repay. That stumble became a dive when the “credit crunch” amplified things, causing a slump in private consumption and investment that might have been far deeper without a rise in public debt.
The problem for Osborne (and his successors) is that on present trends, private and public debt will not have been brought back down before interest rates start rising. The house-price and private spending recovery could encounter a second reversal. And this time, caught with its debts up and its credit ratings down, the government may lack the capacity to counter the downturn the way the Americans did.