Chart of the Week: Deleveraging

We end the week with 2 charts from a recent report from the McKinsey Global Institute “Debt and deleveraging”, which provide elegant snapshots of “progress” of debt and deleveraging by the 10 largest “mature” global economies.

The first chart (but second in the report) shows the composition of debt by country. Notably Japan is leaps ahead by gross debt levels (but as argued later in the report at around Euro levels when netted off), as is the UK, mainly because of “The City”‘s insatiable diet for financial debt instruments:

Australia is near the bottom of this medal like tally – but note the total: some 277% of GDP vs Germany at 278% or the US at 279% or even Italy at 314%…..

I thought we had low debt? Yes, low gross government debt at only 21% of GDP, but in terms of household debt it is the largest of the list at 105% of GDP (as of Q2 2011), more than double that of most European countries. Further, our financial debt is also on a par with the European core, and actually double that of the United States.

But what about deleveraging?

The second chart, although busy graphically, shows that the change in debt in the UK, Spain and France since 2008 has been, well explosive, and only surpassed by the tremendous government stimulus (and huge structural deficit) by Japan since the GFC:

Before looking at the deleveraging since the GFC, note the change in debt in the runup: Australia is mid tier, having increased its debt position by 77% of GDP, alongside the likes of Italy and the United States, but still behind the front runner the UK.

Note that the US has deleveraged by 16% (by both households and businesses) whilst Australia has delevered by 14% of GDP. Although real GDP has improved, total debt levels have not fallen, and in particular household debt has increased by nearly a quarter of a trillion dollars since November 2008, whilst the only outright deleveraging has been done by corporate Australia:

The report is an insightful read and questions what progress can be made by economies saddled with debt – regardless of the composition:

Understanding the course of deleveraging will be of critical importance both to business leaders, who will need to take a granular approach to strategy, and to governments. The report examines implications for business strategy and suggests that current macroeconomic models do not fully capture the impact of deleveraging on demand—so companies must develop their own views of how deleveraging is proceeding to find pockets of opportunity in the near term.

Overall growth in the time of deleveraging is likely to be restrained, but the pace of debt reduction varies across nations and sectors and from place to place within nations. No single country has all the conditions in place to revive growth.

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  1. Nice one Prince.

    “No risk here then” with housing, and other elements like credit card debt.

    We certainly can claim to be different.

      • I wish someone from MB is happy to investigate this big claim from Alan Kohler in yesterday’s ABC News and his blog:

        He claimed that property price in Australia actually has moved in line with income in the last decade ??? I could not believe it for 1000 years…

        • Deus Forex Machina

          That’s the standard RBA line and one that an RBA insider confirmed there belief in to me last year.

          Datsword had a look for me a while back and I think it is correct.

          the RBA argues that they popped the bubble (HnH we know you disagree) in 2003 and since then prices have gone up in line with incomes.

          But isnt one a stock and a flow – if a 500k house rises 3% thats 15k while a 70k income rising 3% is only 2.1k – i’ve never understood why this is seen as a good thing…seems like a dog chasing its tail

          happy to be enlightened

          • Sorry mate still not getting it. My understanding is based on Demographia the ratio of housing property to income is much more than that ? Unless they use different method e.g. median v. average or individual v. household income ??

          • Deo,
            I *think* it partly depends on which measure of income you use.

            Relying on median wages produces price/income measures similar to those produced by Demographia.

            Relying on aggregate national income figures produces results similar to those in Kohler’s article.

            Happy to be corrected.

          • >He claimed that property price in Australia actually has moved in line with income in the last decade ??? I could not believe it for 1000 years…

            Maybe it is true if you look at certain aggregated stats, but I am not exactly sure what the point is.

            Household indebtedness rose considerably in that time period. Please see here ( left side of graph 3.6 )


            All I can see from those stats is that compared to 2003, 2011 house prices are relatively as expensive. Does that mean they are affordable ?
            I guess that depends on your financial circumstances, but the growth in debt relative to income suggests that the rate of growth in prices is unsustainable.

            I think that is the important point that is ignored by this comparison.

          • …and it’s not really the ratio that counts anyway…

            Not as much as the trends of fraction of total income that having such a property consumes via a mortgage.

            If that has been increasing (which I believe it has been) then it is implied that there is a reliance on increasing fraction of income going to supporting ever higher prices – and, that, hence, is the catch: eventually, there is a “crunch point” where the fuel (increasing income fraction), so to speak, of increasing house prices, runs out, either because it cannot (inability) or will not (refusal) increase.

            Such a system, is by its very nature, unsustainable, having a Ponzi-type structure.

            My 345345345 cents

          • I can’t enlighten you DM, but I can tell you the claim is oft-argued by housing bulls – and bears absolutely no relationship to any empirical reality on the ground I can see. The value of my house has increased very strongly in a decade, yet despite the fact that our household income has increased quite significantly in the same time, we would struggle to afford the same house again, even at todays low interest rates. Though I would not be surprised if the incomes of the RBA board members might easily have boomed over that time.

            It’s one of those cases where the official statistics just seem completely divergent from the reality lived by many. If it were factual, it would be hard to see why the housing market remains stalled.

        • kohler is a jounalist, nothing more and his branch out into financail advise has been devastating for many. this is what he said in eureka report late december:

          “IMPORTANT: I believe the conditions are in place for another major panic sell-off on the sharemarket. I don’t know when it will happen and it is not a certainty that it will happen (nothing is ever a certainty), but I think the risk is now such that you must take action. On Monday I will be significantly reducing my already reduced exposure to equities, possibly to zero.”

          this prompted a wave of panic selling in the share market on the day. stock market is up 5% since he made that call too bad to all his retail subscribers that just crystalised massive losses right at the bottom!

          good post though price. the RBA is going to have to slash interest rates big time to cushion the blow form the household deleveraging.

  2. Fantastic information, which hopefully the pollies will be shown by their staff.

    It would be interesting to know how much of current household debt is divided between home mortgage, investment property mortgages, credit card debt and other debt.

    As its reported that only 40% of home owners have a mortgage, I assume that home mortage debt will be a fair part of total Australian household debt (the good part as far as I am concerned altho I know others might disagree) and its the other part of the debt that Australians really have to pay down. However with business/government ecncouraging retail spending and some form of ‘confidence’ returning I fear Australians, who might really not be able to afford it, might go on a feel good retail splurge again.

    • Well, according to the latest RBA stats available for september qtr, Total household debt to disposable income was 150.8.
      Of that, housing was 135.3, of which owner occupier was 91.5.
      So, approx 89.7% is housing debt, of which 67.6% is owner occupier, the rest I guess is investor?
      You want table B21.

    • Or look at Bank Lending in table D5.

      It tells you lending to persons is 1174.8 with owner occ housing 713.5 and investors 355.2 and other 106.0.
      So 91% of lending is for housing, of that 67% is owner occ and 33% investors.

      • Well not quite – there is a lot of business lending masked as consumer home loans, so the actual household “consumer” debt is lower than the totals – how much? no one knows…

        I also note that Australia was only one of three countries to delever so I think that the general bleating is a little excessive.

        The UK financials are a great concern though.

        Corporate debt is not high, so although household debt is high it is manageable in the absence of high unemployment or high interest rates. Yes there is likely to be an uptick in unemployment, but it will still be at quite low levels. I would be more concerned if corporate debt was at high levels.

    • Is it common to use the primary residence as equity when buying investment properties? Is it common for family members to guarantee loans for one another?
      I hope the answer is “no” to both.

  3. What gives with Japan? There seems to be no limit to how much debt they can take on. Them aside (and the UK too) the others are moving sideways. I think they will continue to move sideways — as will the sharemarket and the property markets. It’s a sideways world now.

    • Well the Government there is taking on some pretty massive debt to pay for the reconstruction of the tsunami areas. The additional debt burden is a topic of some contention there- as there will be specific bonds issued regarding this funding.- I vaguely remember seeing graphs showing how much they (didn’t) add to the national debt.
      The population does seem to be querying debt levels (at last?), but they don’t really have a choice.

    • We know that Japanese govt debt is 95% owed within its national borders. The debt consists of the following:

      — A govt-administered pension system which is probably the largest in the world. Remember that Japan has a demographic problem with older people (even though they will not admit to the problem)

      — Massive public works spending (Japan pours substantially more concrete than the US) to create jobs and distribute wealth. The highways are simply incredible with kilometer-long tunnels carved into mountains) and a tarmac-like quality. These public works are funded by govt bonds issued through the post office to Japanese citizens. The Japanese post office was once the largest source of private savings in the world. It possibly still is.

      — A massive public sector that is prone to corruption and largesse (though it has improved much over the last 10-15 years)

      — A health system that is second-to-none but which is overly wasteful and subject to rip-offs by employees. The aging population doesn’t help either.

      — A sales tax of only 5% doesn’t help and is the govt’s biggest headache. It can’t raise it for political reasons.

      • They are raising it to 10% in the next couple of years. It will be a hard sell, but the current gov’t is making the point that it is needed to cover tsunami and aging costs.
        One of the reasons that the current party is in power (or not one, many) is due to the perceived corruption around many of the issues you mention.
        Tax in general there always seemed quite low though.

        • Tax in general there always seemed quite low though

          Until you start adding it all up. As well as income tax and consumption tax, there are also hefty local government taxes, expensive compulsory health insurance, and dozens of other small taxes. My feeling is that the net result is about the same as here, but having to pay for each individual tax separately felt a lot more painful.

          Taxes in Japan are generally based on the income for the previous year, and if you weren’t living in Japan during the previous year your income is regarded as zero and the taxes are correspondingly very low. This tends to warp the impression that foreigners have of Japan being a low tax country.

  4. best post of the year so far. Even my wife can understand it!

    The Aus govt has 5times LESS debt than aussie housholds. (and STRUGGLING to make its surplus promise by 2013! – which i think is stupid by the way)

    Quick. Run. Tell everyone. Scream from the rafters of your expensive McMansions !!

    Business has seen the writing on the wall for a while, but the average joe cant see around the 60′ plasma.

  5. Australia screams into top place for the most household debt. WIN!

    I thought I’d seen this chart elsewhere recently, and a quick search through ZH proved me right. But the figures aren’t the same, even though they are both from Haver Analytics. Strange. The ZH one has the total UK debt at near 1000% of GDP. It’s here if anyone is interested…

  6. Jumping jack flash

    Excellent analysis and an excellent article.

    There are a few points that stood out for me:

    Our total debt to GDP is on par with countries like the US and Germany who are classically far more productive than our little banana republic.

    And although our government debt is fairly low, imagine if they had to bail out the banks and it rose to a more standard figure. We’d be looking more like Italy or Spain.

    And we have a tiny population yet have the greatest amount of household debt to GDP.

    What a robust country we are. No risk here. No sir! Move along, rating agencies.

  7. Let’s assume, for the sake of argument, that the ratio of house prices to incomes and rents is the same as it was ten years ago. Both Alan Kohler and The Economist magazine would conclude from this that the the two situations are somehow “the same”. The key point that both of them fail to take notice of is this:
    Ten years ago, Australian workers were underpaid (compared to Britons, Americans, and others) and were also enjoying cheap rents. So there was plenty of scope for both incomes and rents to rise substantially in (what was then) the future. Today, Australians are overpaid (compared to those in other countries) and are paying a relatively high portion of their income in rent. Therefore, there is very little scope for either incomes or rents to rise much in (what is now) the future.

  8. I dont understand why Germany’s financial sector debt is so much higher than US financial sector debt as a % of GDP. Can anyone explain?

    Thanks for the post.

  9. AU % sums to 276 same as Adanac.

    If the RBA keeps dropping the rate this year us self-funded Ps will be ‘deleaveraging’ our income. I’m already contemplating a 2% cut.

  10. I am bit surprised that in a discussion of debt including sovereign debt there is no mention in the article or comments about Modern Monetary Theory (MMT) or chartalism.

    Any government that issues, borrows and spends in its own fiat currency is never revenue constrained and never need default.

    When the private sector needs to delever the government sector spends more to offset private saving and maintain GDP (assuming a static external balance). Japan is the classic example of this.

    So the debt of Euro nations is a real problem (except for ECB fudging) as they are income constrained and can’t create currency to spend to maintain GDP and employment because they have no monetary sovereignty. Greece, Ireland and Spain are classic examples of the impacts of austerity on countries which are users of a currency they don’t issue.

    The Euro users are like being on the gold standard or under a fixed exchange rate like Bretton Woods.

    Argentina was a case of a country which although it issued its own currency but pegged it to another and borrowed in another rather than retaining its monetary sovereignty.

    Japan, US, UK and Australia are in a different situation, except to the extent they have liabilities denominated in currencies other than that which they issue.

    Understanding this difference Euro users and other countries is basic to understanding the options available to different countries.

    Bill Mitchell (Billy Blog) and Cullen Roche (Pragmatic Capitalist) have written extensively on this and the understanding is starting to permeate the mainstream media.

  11. A second comment if I may.

    It would be interesting to know how much of US deleveraging is voluntary saving as opposed household and commercial real estate debt writeoff after foreclosure. With house prices down about 30% there is a lot of debt being written off by someone.

    Perhaps the US household sector is not deleveraging in the normal sense of the word.

  12. Thank you for that link. One of the best articles I’ve read in ages.

    I think you left out the best chart though, which for me is Exhibit E2.

    I can’t post it here so you’ll have to get the article yourself.

  13. How very interesting. Most national debt calculations look at business, consumer and government debt. Financial debt is disregarded – neo-classical blinkering. McKinsey kindly lists this and voila!

    The Oz banks have borrowed very heavily overseas and sprayed it around. They have gambled that:

    1. The $A will remain strong or strengthen. Were the $A fall to, say, US 0.70c the banks would face horrendous losses. Better hope NE Asian demand stays up AND they fail in their determined effort to diversify suppliers. Pray the bank’s hedging is correctly calculated and wholly with solvent counter-parties.

    2. Their debt can be rolled forward at all times on reasonable terms. One of the rules of commerce is that any gate that can be closed will be closed from time to time – even if only out of owner curiosity to see what happens. If Oz banks willingly pay 1.75 over LIBOR, they might pay even more. Let’s see, say the money providers.

    3. Oz land prices securing the debt will power on forever. Don’t make me laugh. Housing and retail are in oversupply. An army of negative gearers have their finger on the sell trigger, just waiting for further confirmation of the downturn in land prices.

    That financial debt is going to hurt us, big time.

    • I agree with your sentiments and overall conclusion David. However it is incorrect to suggest that our banks have FX exposure from offshore issuance. All foreign currency denominated bank paper gets swapped back into AUD (BBSW + x), and any residual currency exposure gets hedged. Furthermore, it is not a margin over LIBOR that our banks are paying for funding, rather a margin over 3m BBSW.

      That doesn’t make the situation sustainable mind you!

  14. tomjconleyMEMBER

    Great report and article. I’ve plans to get round to reading it in detail soon. With regards to your first chart, I’ve always thought that gross debt was virtually a meaningless measure. See for discussion. The foreign/domestic nature of debt is also vastly important. This is especially important in the case of Japanese public debt. The Japanese are basically lending money to each other, which is vastly different to the situation in European countries, especially Italy. The other thing to consider is the issue of double counting. How much of that financial sector debt is on lent to households, thus boosting both figures. Don’t get me wrong here, I think private debt in Australia is a big problem and public debt is a big problem in Europe. While we talk about structural change a lot, one major long-term structural change has now ended – that is the shift to a debt financed growth model over the past 25 years or so. The developed world will have to develop an alternative growth model if it is to get out of what could be a long period of stagnation.

  15. ColinTwiggsMEMBER

    I agree gross debt exaggerates the extent of Japan’s predicament compared to net debt. They hold the largest offshore financial assets. Net debt should also be used to evaluate exposure of the Financial Sector as they largely act as intermediaries for the Housing and Non-Financial sectors.