The debt that killed the UK economy

Back in April, Dr Oliver Marc Hartwich from the Centre for Independent Studies wrote an article in Fairfax on the worrying parallels between the UK and Australian economies and housing markets.

The current mood in Australia triggers eerie memories for me. I feel as if I have experienced this scenario before – not in Australia but in Britain.

I moved to London in 2004. The ”cool Britannia” euphoria had ebbed away during the Iraq War but, at least domestically, the country was still at ease with itself. Gordon Brown, the Chancellor, celebrated prudence as the guiding principle behind his fiscal policy. The City of London was rivalling New York as the world’s financial capital, and the British housing market was booming…

Britain was going through the longest period of growth in its history. However, the more I looked behind the facade of the growth phenomenon the more unreal it all looked…

Britain’s growth had been built on four pillars that were all unsustainable. First, strong migration, particularly from eastern Europe, had boosted nominal GDP. Second, rising house prices had eroded the savings culture. Third, the private sector had become dependent on the property market to finance its consumption. Fourth, public debt had risen almost every year despite a booming economy…

Since then the British economy has indeed demonstrated how unsustainable its foundations really were…

Australia is not Britain… But there are worrying parallels as well. Although Britain had experienced big swings in its housing market in the past, the British had bought into Gordon Brown’s creed that the era of booms and busts was officially over. Consequently, they could no longer imagine significant corrections in the housing market. But that did not stop the property crash in 2008.

In Australia, there is much debate about a potential housing market bubble. There is only agreement that property is expensive. Whether it is also too expensive is hotly disputed.

It is nevertheless surprising how fiercely some economists and analysts fight the notion of a housing bubble. They point to strong demand, artificially limited supply, and the preferential tax treatment for real estate to justify their view that Australian housing is not fundamentally overvalued and thus not heading towards a correction. Although their arguments have merit, the very same arguments were also used by British analysts before the British housing market went into free fall.

The most frightening parallel between pre-crisis Britain and Australia today is more fundamental. In both cases, there was a dominant understanding that the countries had found their steady and stable growth model. In Britain it was based on financial services and house prices, in Australia on minerals and China.

In a similar vein, Money Broker, Tullett Prebon, last month released a fascinating Strategy Note highlighting the precarious position of the UK economy following its debt binge over the 2000s. Again, the analysis provides worrying parallels for Australia, which has engaged in similar, albeit less extreme, levels of borrowing over the past decade.

Below are some of the key extracts and charts from the presentation, split into themes.

Debt addiction:

First, the Strategy Note provides a detailed overview of the increasing indebtedness and debt-dependency of the UK economy.

Over the past decade, the British economy has been critically dependent on private borrowing and public spending. Now that these drivers have disappeared – private borrowing has evaporated, and the era of massive public spending expansion is over the outlook for growth is exceptionally bleak…

During 1996-2002, aggregate public and private borrowing averaged 4.9% of GDP. Between 2003 and 2010, however, aggregate borrowing averaged 11.2% of GDP and, with the single exception of the 2008-09 crisis year (7.8%), annual borrowing never fell below 10.4%…

A key feature of the British economy since 2002 has been the emergence of long-term dependency on borrowing at least 10% of GDP, year after year.

Moreover, the overwhelming majority of this borrowing came from overseas… During the boom years, British banks customarily funded their domestic lending from international wholesale markets, a process which not only contributed to a massive escalation in gross external debt (from £1.9 trillion at the end of 1999 to £6.4 trillion by end-2008) but put the banking system into an immediate crisis when, in 2007, the supply of wholesale debt dried up virtually overnight.

Resource misallocation:

Next, the Strategy Note provides insight into how the UK’s debt binge misallocated resources by spuring activity in the non-tradeables sector of the economy at the expense of the tradables sector.

The critical economic role played by debt is reflected in divergences between the performances of different business sectors… Over the past decade, borrowing has driven up output in financial services (+123%), construction (+27%) and real estate (+26%), whilst lavish public spending has propelled expansion in health (+35%), education (+27%) and public administration and defence (+22%)…

Real output in all other industries is now 5% lower than it was ten years ago.

Between them, real estate, finance, health, education, construction and public administration are six of Britain’s eight largest industries, and account for more than 58% of output…

Diminishing returns from debt:

A worrying aspect of the UK’s debt binge over the 2000s was that it was channelled toward non-productive activities, such as housing speculation and consumption. As a result, the UK economy received diminishing returns as its debt levels grew.

The following is my favourite part of the report and the section which, in my opinion, offers the greatest lessons for Australia.

Borrowing-addicted Britain gained ever less growth from each successive increase in debt… After 2000-01, and just as borrowing began to escalate, growth stagnated, showing no gains whatsoever over the preceding (1996-2001) period. Indeed, trend growth was a lot lower during 2002-08 (2.6%) than it had been in the earlier period (3.5%)…

The problems facing the UK today are the direct result of reckless consumption by individuals and government alike, the former funded by equally reckless lenders. Now, and although the public are not yet aware of it, the bill for this era of unheeding greed has turned up. To put it colloquially, many of the imported gadgets might already be in landfill, but the debt incurred to buy them remains.

If Britain’s economy has indeed become dependent upon annual debt increments exceeding 10% of GDP, why was there not at least some improvement in growth rates? The conundrum is one that asset managers term returns on capital employed – Great Britain plc has increased its capital (debt) base very markedly without generating any improvement at all in income growth. Why?

To understand the conundrum posed by a growing capital (debt) base and diminishing growth, we need to distinguish between two types of debt. These are termed ‘self-liquidating’ and ‘non-selfliquidating’ debt.

If the owner of a successful restaurant borrows to invest in additional seating space, the debt is selfliquidating because it will be serviced and paid off from the higher income that the expanded restaurant will generate. But borrowing to pay for a new car or a foreign holiday is non-selfliquidating, because it is a form of consumption which does not leverage the borrower’s income. Though the parallels are necessarily less than exact, the sharp fall in Britain’s return on capital reflects the fact that the overwhelming bulk of new borrowings have been non-self-liquidating…

Government has been guilty of over-consumption, and very little has been invested in self-liquidating projects such the improvement of the country’s road, rail, power or telecommunications infrastructure.

But the biggest problems have not been caused by government, but by individual borrowers.

The biggest single debt increment during the period between 2002 and 2009 was mortgage borrowing, which increased by £590bn between those years. Many borrowers saw this as investment, a view which was profoundly mistaken even though many policymakers and even bankers managed to delude themselves otherwise. As average property prices soared from £121,000 in 2002 to £197,000 in 2007 (a real terms increase of almost 70%), escalating mortgage debt looked like an investment, and a good one at that.

But to believe this was to overlook two critical points.

The first point that was generally misunderstood was that property prices, whilst realisable on an individual basis, are not realisable in the aggregate. Therefore, and as borrowers and lenders alike were to discover, property prices, far from being an absolute, are an example of ‘notional value’.

The second reason why the escalation in mortgages was not an investment was that a steadily diminishing proportion of new issuance was actually going into the purchase of homes – by 2007, only 35% was being used for this purpose, with the balance going into buy-to-let (BTL) (26%) and equity release (39%). Whilst BTL might have looked like an investment, the reality was that it was a low- or negative-return punt on property prices continuing to rise ad infinitum. Equity release, meanwhile, amounted to the direct leveraging of balance sheets into consumption.

That the property market could not go on rising indefinitely was demonstrated in dramatic fashion when average prices fell by 19% between 2007 (£197,000) and 2008 (£160,000). Despite this correction, property prices still look very exposed in terms of earnings multiples, which remain far above historic norms…

The harsh reality is that the overwhelming bulk of private borrowing during the Brown era was channelled into immediate consumption. ‘Spending like there was no tomorrow’ showed how the public had bought into the ‘easy money’ mentality of the ‘Brown bubble’, but individuals can hardly be criticised for this, since government itself had done precisely the same thing, increasing public spending by more than 50%, in real terms, between 1999-2000 and 2009-10.

Dire outlook:

The Strategy Note provides a bleak outlook for the UK economy.

In a nutshell, private credit has turned negative and is likely to remain subdued for an extended period. Home prices are still way overvalued, eliminating the prospect of a significant pick-up in mortgage borrowing. And with the Government committed to all but eliminating the budget deficit by 2015-16, the Government will be unable to fill the void in the economy left by the reduction in private sector credit.

Past dependence on substantial levels of annual incremental borrowing has put Britain into a high-debt, low-growth trap. Because growth was feeble even when fuelled by the continuous injection of debt-funded demand, the outlook, now that the country’s borrowing capacity has been maxed out, may be for extremely low economic growth. The collapse in private borrowing has dreadful implications for two of Britain’s eight biggest industries (real estate and construction) and may have adverse implications for a third (financial services).

Another three big sectors (health, education and public administration and defence) are necessarily ex-growth now that the expansion of public spending is over. Together, these six sectors account for 58% of the economy, which makes the delivery of aggregate growth very difficult, and perhaps impossible.

The UK is already showing unmistakeable signs of economic deterioration. Real incomes are declining, a trend to which individuals are leveraged by the high and increasing cost of such nondiscretionaries as food, fuel and utility bills. To make matters worse, interest rate rises seem inevitable, either for policy (inflation) reasons or because of bond market jitters. If the outlook is indeed for low growth, the government’s growth-dependant deficit reduction plan won’t work. And, if the plan were to come unstitched, sterling would come under severe pressure, exacerbating inflationary pressures and compounding the misgivings of international investors holding British debt.

Although Australia’s large resources sector and healthier public finances reduces the likelihood of a UK-style meltdown, these differences could lose relevance in the event that the Chinese economy experiences a hard landing.

Then Australia’s ‘miracle economy’ might suddenly look more like a mirage. And we will wish that we had the foresight to establish a sovereign wealth fund that saved some of the bounty from the mining boom for a rainy day.

Cheers Leith

[email protected]

Leith van Onselen


  1. I dont care what anyone says on here but sooner or later all this debt in Australia is going to catch up with the economy. The mining boom is keeping the economy out of a GFC but I really dont think it will do that forever. Australia will have to go through it like everyone else.

  2. Jumping jack flash

    Yes, according to Glen of the RBA we need to be thankful for the mining boom, suck it up because it could be worse (just look at the UK, Ireland, US, Spain, Greece, etc who don’t have any special dirt and a China to sell it to), and keep paying off that mortgage instead of spending money on other things.

    Any pain felt by retail tourism and other discretionary sectors will more than be made up for when Futureboom! arrives. It’s just around the corner. I swear. I’ve seen it. Any minute now… Hold onto your hats here it comes. Brace yourselves.

  3. “The first point that was generally misunderstood was that property prices, whilst realisable on an individual basis, are not realisable in the aggregate. Therefore, and as borrowers and lenders alike were to discover, property prices, far from being an absolute, are an example of ‘notional value’”

    That’s it in a nutshell. China might just be able to save the government but private debt is crippling most of this country already and will continue to do so for some time yet.

  4. I don’t know whether we can realistically think of a sovereign wealth fund as long as the AOFM has to place approx. A$700m a week of bonds to finance the current deficit and other spending programs.

  5. Ref the UK, have a read of this link for some sobering analysis on this topic:

    Likewise the comments about Australia and it really is all about the debt. We have relatively low government debt, but that is growing at a rapid rate under this government so a risk. Also personal debt, and we have a massive problem with housing debt, the ongoing financing of that debt.

    If rates stay low we might over time escape, but I would not count on smooth sailing with the underlying inflation.

  6. Britain are paying, big time, for letting the government sector become such a massive part of the economy as well. Yes, private sector debt is a major issue, but 50% of the economy is government spending. In some parts of the country it’s much higher than that.

    Fair enough, regulate financial markets to keep economies stable and massive debt (private and public) creates huge potential problems. But let’s not forget, economic theory is about efficient allocation of resources, governments simply cannot do this, no matter how hard they try. It is just impossible for them to manage it.

    As essential as much public sector spending is (police, courts, roads etc…) all government spending drains the wealth of the nation. The best thing for governments to do is as little as they can (or only as much as is absolutely required). Big-governments create big-bureaucracy and as anyone who has dealt with bureaucracy knows, it’s like getting stuck on a round-a-bout with no exits, only to FINALLY find an exit, but it leads to yet another round-a-bout.

    The UK is a place of high taxation and massive government spending. Two things that totally kill REAL productivity growth.

    They need to take their medicine because the longer they wait to cut government interference in the economy, the worse the harder recovery is going to be.

    • Totally agree MattR. The UK is a case of bureacracy gone mad. Unfortunately, I see Australia heading down the same road.

      Having worked in both the Federal and Victorian Treasuries, I have seen government from the inside. And I believe that Australia should significantly reduce the number of back-office bureaucrats and possibly direct some of the cost savings to the front-line public servants (e.g. nurses, teachers and police) that actually serve the public.

      In my opinion, Government should focus on providing essential services and infrastructure, and not much else.

      • “In my opinion, Government should focus on providing essential services and infrastructure, and not much else.”

        Couldn’t agree more, also we should not forget the role of councils in all this as well. It’s not just back office bureaucrats in big departments that are killing us with red tape.

        I have heard some horror stories (I also have my own).

        • Me too. I live on a corner block with a 9.5m set-back from the street. As my front yard is much bigger than my backyard, we want to add two rooms to the front, which would reduce the set-back to 6m. However, the council will not allow this as it would ruin the ‘street scape’ (since my home would no longer be in-line with my neighbours). Yet it would be fine for me to demolish my attractive 1940s home and build a gastly McMansion in its place (wtf!).

          The council is also making it difficult and costly to errect a simple 1.8m fence (only 1m fences are allowed without a permit). We are required to submit architect plans and pay around $1k in fees in order to gain approval. Crazy stuff.

          No wonder nothing gets done any more… We are drowning in red tape.

          • I recently obtained some prior plans for my property, for major renovation work it was a simple sketch and off you go.

            Comparing that with what i have to do now to get anything done shows just far down the path we have gone. Councils have gone mad with power.

            I had a similar experience with you regarding alterations. i wanted to go with a dual occy on my property, but hey the land size requirement got changed a couple of years back so bad luck. Oh and to alter your current place you are SOL due to the streetscape et (similar set back to yours in fact, though other properties have significantly less in the same street). Our rates increase year on year for the privilege of having some dumbass dictate terms for the use of our private property!

            If we could abolish councils i would be a happy chappy. It would sure fix that “housing shortage” in a jiffy…

          • sounds scarily familiar to me as a kiwi.
            Just recently a mate wanted to build a minor dwelling and accessory building on his rural lifestyle property. It needed a consent (planning permit) from the Council for some minimal earthworks – that is a joke in itself. But then the Council planners thought they could interfere in the design of the household unit (legally their assessment had to be limited to earthworks issues), they even wanted him to put a fence between the minor dwelling and the accessroy building, treating the two buildings as if they were on 2 separate properties under different ownership. It was just bizarre! The wranglings went on and on for months before the planning manager stepped in and agreed it was all ridiculous. But not before my mate had missed the building season (has to wait to the coming spring)
            Totally agree that there should be far less of these expensive and obstructive paper shufflers, and more (and better) frontline services

        • I will see you and raise.

          We almost bought some agricultural land that had a physical easement (i.e access road) on the western boundary that the farms behind us drive on to get to the street/home.

          Except, on the plan, the easement went through the middle of the property.

          No problem I thought, get council to amend the plans to reflect reality.

          Nope – $10,000 quote later, I needed a new Development Approval, full survey, and I might be up for having the whole easement bitumenised/concreted (talking a couple hundred meters here….)

          For changing two lines on one piece of paper. Suffice to say, we didn’t buy.

          • Did the Council application cost $10k or was it the private consultant’s fees? I seriously doubt the Council application came anywhere close to that cost… from my experience it’s the bloodsucking private industry that rakes those ‘not in the know’ over the coals.

            I had an easement application in my local, and they introduced an easy to use system for us laymen to do our own development application as well as a step by step free booklet.

            Cost me $650 to Council for them to do the assessment and nearly 3 times as much for a private surveyor to draw those little lines on a page. Probably took the surveyor about 2 minutes with autocad.

            Oh and I got 5 quotes for the easement development application before calling the Council who showed me that I could do it myself. Cheapest private consultant wanted $6k… the top tipped out at $18k. Total wrought.

          • Ah, the cost of risk mitigation in the brace new economy. A tax on you to save the local government the cost and loss of $ through a potential court case.

      • And how about a little dept. tasked with regulation of financial matters? That might go a long way in prevention of the sort of things that keep us all awake at nights…

      • As another who has first-hand experience within govt I couldnt agree with you more.

        The smaller the govt the better it is for our nation. That should be so self-evident i cant believe i even have to post it.

      • The_Mainlander


        “In my opinion, Government should focus on providing essential services and infrastructure, and not much else.”

        Nice Leith, totally agree.

        I think that in the PS it is still a job for life… why?

        Australia has way too many layers of PS’s for such a small country and also such a young country.

        What’s the point?

        With the Super issues to come (Hey isn’t that real reason for the Future Fund to fund PS retirement?) we all should work for the PS to get a FREE ride.

        Also, personally After contracting in the PS for the last year I can say it is a joke… people cruise in after 9am chat… eat there play lunch, off for coffee, back to chat some more maybe some email then head off about 4pm. Really it seems like day care for adults!

        I have been consistently disappointed with there lack of drive and no care for outcomes or accountability.

        But hey that is just my subjective take.


      • Totally agree with this. More money needs to be diverted to real service delivery and away from ephemeral backroom analysis which is often duplicated in bureaucracies and therefore has its own cost multiplier and inherent inefficiency. Literally produces nothing, information for today that is forgotten tomorrow. A common theme seems to be growth and productivity. Perhaps we need to focus more on productivity and quality. Growth implies we need to expand as an economy, why? Why do we need to expand? Can’t an economy work as a beautifully oiled machine. Progression is important but perhaps economic speak talk needs to shift away from “growth” as equal to “progress”

  7. I think that the fundamentals in the UK are different to Australia, as in a huge part of the GDP in the UK is generated by the “square mile” also they have a far greater welfare state. There was also the issue of easy credit for anyone that held a job, to the point where there was a show on TV on how people with massive credit card debt were shown how to pay it down. There were a lot of people that had the equivalent of a years wage owing on credit cards.

    However, having lived there for 7 years I am seeing exactly the same mentality here with the credit / loan / equity mate binge.

    Further to that I see that the govement here has got the same “browitis” that caused the problems for the UK, Gordon probably did more harm to the UK than Hitler. By this I mean bloated goverment and councils, selling of assets to be able to balance the budget, cut backs on essential services like police, fire, nurses, health care.

    I think that Australia is in for a huge wakeup, people have gottten used to / expect to make a lot of money for doing very little, this is going to change and the recession that we need to have is going to bring some “sanity” to prices and services along the way.

    This does all depend on how strong the goverment is, at the moment we are stuffed.

      • Yeah, and it gets better and better for Fred Harrison.

        In a book called “The Chaos Makers”, published in 1997, Harrison contributed a portion entitled “The Dreamers, the Deceived, and the Coming Housing Crash”.

        Harrison declared that “the property boom of 2000 will come as a shock to Gordon Brown; who, if he is still presiding in Britain’s Treasury in the first decade of the millennium, will… be politically traumatised by the astronomical unearned gains from land that will be pocketed by shrewd operators who know how to manipulate the tax system.” Harrison stated further that: “the consequence is predictable. By 2007 Britain and most of the other industrially advanced economies will be in the throes of frenzied activity in the land market equal to what happened in 1988/9. Land prices will be near their 18-year peak, driven by an exponential growth rate, on the verge of collapse that will presage the global depression of 2010. The two events will not be coincidental: the peak in land prices not merely signalling the looming recession but being the primary cause of it.”

        There must be something about having the name “Fred”, because…….

        Fred FOLDVARY’s “The Business Cycle: A Georgist-Austrian Synthesis.” was published in an academic journal in October 1997.

        From Foldvary’s final paragraph:

        “The 18-year cycle in the US and similar cycles in other countries gives the Geo-Austrian cycle theory predictive power: the next major bust, 18
        years after the 1990 downturn, will be around 2008, if there is no major interruption such as a global war. The Geo-Austrian synthesis provides
        a research agenda that can test historical cases in more detail. Much work needs to be done on empirical studies linking the money supply,
        real estate markets, and business cycle……”

    • And Brown wanted to be the IMF MD, and thinks he saved the world in 2008 – no alarm bells….

      I lived there while he was Chancellor, and then PM, and around 2005 we started to see wage deflation, and lots of industry fail, not to mention the housing bubble. Bankers however did very well with Gordon’s blessing. Lots of other bad fiscal management, and it still took a coalition to oust Gordon, Balls and crew.

      I totally agree with UC on Australia heading the same way. It’s all about being in power and nothing to do with the good of the country or it’s citizens.

  8. Alex Heyworth

    Good post, Leith. One para in particular caught my eye

    “In both cases, there was a dominant understanding that the countries had found their steady and stable growth model. In Britain it was based on financial services and house prices, in Australia on minerals and China.”

    There is only one steady and stable path to growth, long term, and that is productivity improvements. If a nation does not produce more, it cannot consume more. Full stop. Even a politician ought to be able to understand that.

    • Alex Heyworth

      PS, time to update an old poem?

      “We’ll all be Brooned, said Hanrahan …”

  9. The British housing market “crash” wasn’t bad as all that. I owned a house in South London, purchased mid 2007 and sold mid 2010. We sold it pretty much what we bought it for. The so called crash was felt much more acutely outside the South East and London, areas which really had illusory prosperity, where the local economies are made up of sometimes up to 80% public sector.