Monday, April 2, 2007

Debt Around The World (and aye, aye, aye...)

From a recent OECD study (PDF file) I extract some interesting charts on household debt.

First, the opening paragraph from the study:

"Over the past decade, household debt has risen to record levels in a number of OECD countries. The large size of these debt run-ups, coupled with, in several instances, changes in the characteristics of some of the relevant instruments, are estimated to have raised the sensitivity of the household sector to changes in interest rates, asset prices and incomes. In this sense, the household sector may have become more vulnerable to adverse shifts in these variables."

(Click on the charts to enlarge)

In Chart 1 we observe that household debt has doubled as a percentage of GDP in the past 20 years, now around 80% on average. Economic growth is now heavily dependent on continuous, easy access to cheap debt.

Chart 1

In Chart 2 we observe that around 70% of all household debt is in the form of home mortgages. This points to housing (and housing related debt) as the major driver of OECD economic activity: home mortgage debt is now 55% of GDP, up from 35% just 10 years ago.

Chart 2

The OECD study also contains interesting data on the dispersion of household debt between income groups. Chart 3 shows the distribution of debt by income percentile. It looks like in the US, Canada and New Zealand almost everyone owes some debt.

Chart 3

Another observation from Chart 4 is how much income goes towards debt service: in the US, ninety percent of all households that are in debt must devote around 20% of their disposable income to pay off debt. Only the top 10% are less vulnerable, paying around 12% of their income.

Distribution of debt service burden by income percentile
Chart 4

It boils down to housing activity being the key to the financial health of households and the overall economy. Should home prices and/or credit conditions turn negative the impact to GDP growth will be very significant. The statistics show that this is particularly true for the US (and NZ) as debt loads are high and impact all income sectors.

The end of the real estate bubble is going to have lasting effects and won't be isolated to just the construction and related sectors. I believe that the weakness we are currently experiencing is only the beginning of a mounting problem caused by excessive debt, not a "soft spot" in an otherwise vibrant economy.


  1. Hi Hellasious,

    A great post as always on your talented blob. I'd like to get your opinion.

    Will the US prints its ways out of debts or will a japanese deflation pop in this years when housing prices start tumbling? Which I take for granted. Am I at least right on this?

    Definitely interested in the outcome. I'm sure Trichet will follow on the US monetary policy. With a distant couple of months on any decision made by BB.

    François, Paris

  2. Once again great analysis.

    One interesting occurence so far in the US is the fact that the equity markets are at or near all time highs despite the apparent peak in house prices 9 months ago.

    Normally stock prices tend to break down rapidly after a peak in house prices. Therefore, I figure we are overdue for equity prices to start declining soon. Gross at Pimco believes junk bonds will get whacked first then stocks.

    Keep an eye on high yield spreads.

  3. Thank you both for your kind words.

    As I have often repeated, I think it will be impossible for the US to massively inflate its way out of debt, not the least because it will completely destroy the value of the dollar as a global reserve currency, i.e. the end of dollar hegemony.

    House prices don't need to tumble in order for trouble to appear: if they stay flat for 10 years with inflation around 3%, that will destroy lots of debt.

    Equity and debt markets are now completely interlinked through the CDS market. One looks to the other for pricing signals.

    As for ECB...I think these days the relevant central banks for the global economy are BOJ and PBoC...that's where the money is.

    Try this thought experiment: What will happen to global markets if BOJ and PBoC both raise thir rates 50 bp?

  4. Hellasious,

    Both the PBoC and BOJ have a dilemma on their hands.

    PBoC cannot afford to choke off growth because it is providing jobs for the mass migration of the rural population to the cities. Estimates are that 200 million people will move to the cities over the next decade.

    At the same time, not increasng interest rates threatens to further inflate more asset bubbles and create future NPLs throughout the banking system.

    I think the PBoC will try to keep the party going for as long as possible. So far they have tried to use regulatory measures to control the direction of growth and prevent asset bubbles. I don't see them raising interest rates dramatically unless inflation really takes off. However, I don't think inflation will take off in China. China's ageing population is more interested in saving than consuming.

    The BoJ has virtually the opposite problem. On the one hand, the BoJ needs to raise rates in order to regain monetary leverage lost during the latest deflationary period. On the other hand, the BoJ does not want to cut off growth just as the economy is beginning to experience positive nominal growth rates.

    Unlike China, Japan's problem is that is has too few future workers and consumer demand will continue to slacken even as wages rise because prospective retirees are more interested in saving than consuming.

    If demand for Japanese exports should drop off in the near future, the BoJ will have no ability to jump start the domestic economy with current rates at only 1/2 %. In a deflationary environment, even 0% nominal rates are restrictive.

    My own opinion is that neither China nor Japan can afford to blink first. They are simply too export dependent for their current economic growth.

    Instead, I think that overextended consumers in the West will blink first as they become increasingly unable to finance their debt obligations and can no longer refinance their homes.

    As 5 1/4 short term rates in the US continue to hurt subprime and Alt A ARM borrowers,
    consumer demand for imports will decline placing even greater pressure on PBoC and BoJ to actually reduce rates in order to keep the party going. In such an environment, Japan and China will be inclined to devalue their currencies and reduce export prices.

    The wild card factor in all of this is the rise of protectionism in the US and elsewhere. At least while house prices were rising and MEW was available, workers in the West could maintain high standards of living even as wages stagnated. What will happen now that this option has been removed?

  5. Hellasious,

    did you see the article in NY Times on the 8th of April telling that the economy is already slowing down due to stalling housing market - people cannot spend as they cannot refinance their houses anymore?

    Very interesting times indeed.

  6. i chopped off my penis. very interesting times indeed!! INDEED, MUTTHAFUKKA!!! ARRRRGGGHHHTGGHHGHHHH!!!! I'm bleeding in my pants!!! BLEEDING IN MY PANTS. BLARRRRRRGGHGHHHHH!!!