Jewish World Review Sept. 18, 2013 / 15 Tishrei, 5774
Deleveraging report card: How countries handle the burden of debt
By Robert J. Samuelson
http://www.JewishWorldReview.com | Almost everyone agrees that too much borrowing (a.k.a. “leverage”) was at the core of the financial crisis and Great Recession. Too many risky loans were made. Where do we stand five years after Lehman Brothers? Well, there’s good news and bad. The good is that U.S. households and businesses have cut their debt burdens. The bad news is that in most other countries, they haven’t.
The economic implications are plain. If you’re devoting more of your income to debt repayment, you’re probably spending less at the mall. On paper, Americans’ lighter debt burdens suggest a stronger economy. By the same logic, steep debt levels elsewhere may retard the worldwide recovery.
Let’s go to the numbers. These come from the McKinsey Global Institute — the research arm of the consulting firm — which has been tracking debt in major economies. To measure the relative burden of debts, McKinsey compares them to the country’s economy, its gross domestic product (GDP). Here are McKinsey’s latest findings for the United States.
Start with households, whose debts consist mostly of home mortgages, credit card loans, and auto and student debt. From year-end 2000 to 2007, household debt almost doubled, from $7 trillion to $13.7 trillion. As a share of GDP, it went from 69 percent to 96 percent. That was the credit bubble inflating. But since 2007, household debt has dropped by nearly $1 trillion to $12.8 trillion. The GDP share has fallen to 80 percent. This was the bubble popping: mortgages defaulting and being written off; or borrowers skimping on spending to repay debts.
Something similar has happened to non-financial businesses — companies such as IBM, Google and Wal-Mart. True, their debt rose from nearly $11 trillion (77 percent of GDP) in 2007 to $12.9 trillion (81 percent of GDP) in 2013. But these figures overlook the reality that much corporate debt has been refinanced at lower interest rates. As a result, says economist Susan Lund of McKinsey, annual corporate interest payments dropped by nearly $200 billion from 2007 to 2012, from $551 billion to $369 billion. Lower debt and interest rates did the same for households, whose interest payments also fell about $200 billion from 2007 to 2012.
These developments are a plus for the U.S. economy. Consumers are better positioned to spend, and — if demand strengthens — businesses are better positioned to invest in new production capacity.
Abroad, the picture is darker. True, private debt in some countries is low or declining. Germany’s household debt fell from 73 percent of GDP in 2000 to 58 percent in 2012. Indeed, some economists argue these low debt levels show that Germany’s economy depends too heavily on exports and not enough on domestic demand. But Germany is an exception. Many countries have high private debt levels. In Britain, both household and business debts are near 100 percent of GDP. In Canada, household debt is 96 percent of GDP; in Australia, it’s 106 percent of GDP. Both these countries, says Lund, might suffer housing bubbles with prices collapsing and defaults increasing. This is already happening in the Netherlands, she says, where household debt reached 125 percent of GDP.
Together, what do these numbers mean for the world economy? Bear in mind three realities.
First, there’s no magic debt level — compared to GDP — that’s just right or too much. The amounts may vary by country. Nations with faster growth can usually bear more debt, which can be repaid from rising incomes. Still, the higher debt goes, the more likely it will reach a tipping point that triggers a broad credit pullback (and higher interest rates) or a full-fledged crisis.
Second, just because U.S. private debt levels have dropped doesn’t mean that American consumers and businesses will go on a spending spree. Shaken by the Great Recession, they may reduce debt further or increase savings against future setbacks.
Third, government debt has expanded in most countries. In some, it substituted for contracting private debt. In the United States, government debt (including state and local borrowing) rose from 56 percent of GDP in 2007 to 93 percent in 2013. In Japan, government debt in 2012 was 228 percent of GDP. In Britain, it was 95 percent. So far, financial markets have accepted these high levels without imposing punishing interest rate increases. But despite the talk of too much “austerity,” countries will want to restrain large debt increases for fear of a market backlash. The resulting higher taxes or lower spending could dampen growth.
So any deleveraging report card must be maddeningly hedged. An honest grade is: incomplete.
What explains their lapse? Probably this: Before the real estate collapse, there was a widespread belief that housing prices would rise indefinitely, preventing (by definition) a bubble. We now know this belief was mistaken, stupid and suicidal. But for many, it was genuine. An earlier study by economists at the Boston Federal Reserve reached a similar conclusion.
All this is more than ancient history. It matters for two reasons.
One is to understand today’s economy. Because Americans over-borrowed, it’s suggested that when they’ve adequately repaid debt (“deleveraged”), the economy will improve. Well, they’ve deleveraged considerably. Debt payments as a share of disposable income are at their lowest levels since the early 1980s, according to the Federal Reserve Board. Still, the economy barely limps along. The problem transcends debt. The disillusion with the pre-crisis euphoria has led to an opposite post-crisis reaction. Yesterday’s foolish optimism has become today’s protective pessimism. A Pew survey finds 63 percent of Americans feel “no more secure” than five years ago.
People once thought the future was more stable and more predictable; now they fear it’s less stable and less predictable. Their behavior becomes more precautionary. For consumers and companies, there’s a greater bias against spending, lending, hiring and taking economic risks of any kind. The economy, though not crippled, isn’t invigorated either. With changed behavior, economic models based on past patterns frequently over-predict growth.
The second reason to reexamine the crisis involves policy. The “scoundrel” theory of causation suggests that, once defects in the economic system are identified, they can be rectified with “reforms.” The Dodd-Frank financial legislation reflects this philosophy. The true history of the crisis raises a larger problem. Success in stabilizing the economy in the short run fostered greater long-run instability. What are the limits to stabilization policy? Might more short-term upsets minimize long-term calamities? Economists should be wrestling with these and other hard questions. They aren’t.<
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