Working Out of Debt
John Mauldin
January 23, 2012
This week we look at a report called “Working Out of Debt,” about debt
and deleveraging, from the McKinsey Global Institute. This is a well-done
summary of their longer paper, which has been updated, called “Debt and deleveraging:
Uneven progress on the path to growth.” I discussed the original paper both in my regular letter and in Endgame. It is one of the best, most
definitive pieces on the topic I have read. For those trying to understand how
the deleveraging process will affect their particular world, I think it is a
must-read. I have been
spending more and more time thinking about the whole process of deleveraging,
and am coming to think deleveraging
is the critical and fundamental
factor shaping the economic environment and impacting every decision countries
and businesses are faced with. This paper
was done by Karen Croxson, Susan Lund, and Charles Roxburgh; and they are to be
especially commended for their insight and work.
This summary and the full report look at the relevant lessons from
history about how governments can support economic recovery amid deleveraging,
and at the signposts business leaders can look for to see where economies are
in that process.
Overall, they tell us, the deleveraging process has only just begun:
“During the past two and a half years, the ratio of debt to GDP, driven by
rising government debt, has actually grown in the aggregate in the world’s ten
largest developed economies. Private-sector debt has fallen, however, which is
in line with historical experience: overextended households and corporations
typically lead the deleveraging process; governments begin to reduce their
debts later, once they have supported the economy into recovery.”
You can sign up at their website and see the full report at https://www.mckinseyquarterly.com/Working_out_of_debt_2914.
I would strongly recommend you do so, not only for this report but because
their website is chock full of well-done articles on a wide variety of topics,
and they update it frequently with more material. It is all top-notch. It is
worth visiting just to see what they have done in areas that may be of more
specific interest to you, or because like me you are an information junkie and
want to keep up on a wider world than just macro-economics.
Have a great week. Mine will be busy but interesting, which is
always good. And this Friday I start a series on the choices that we face in
the US, so there will be lots to ponder amidst the noise.
Your
wondering how the Giants got into the Super Bowl analyst,
John Mauldin, Editor
Outside the Box
JohnMauldin@2000wave.com
Working out of debt
McKinsey Global Institute
January 2012
Karen Croxson, Susan Lund, and Charles Roxburgh
An update of our research on the efforts of developed countries to work out from under a massive overhang of debt shows how uneven progress has been. US households have made the greatest gains so far.
The problem
The deleveraging process that began in 2008 is proving to be long and painful, with many countries struggling to reduce debt during a sluggish economic recovery.
Why...
Comments
Steve Correll
Feb. 12, 2:04 p.m.
RE: Exhibit 1
I wonder - How long can the US consumer keep increasing household debt as a % of disposable income? Will the trend eventually flatten out - like the US govt, excessive debt service ratio implies that it must flatten - and what happens when it does?
Jason Nicola
Jan. 26, 11:21 a.m.
Great read, I am finally seeing a faint light at the end of the tunnel!
Edmundo Ventolera
Jan. 24, 11:53 a.m.
I like the headline - WORKING out of debt. Some time ago my personal analysis in a very focused situation was that there were four ways out: pay up, beg forgiveness, sell stuff or work your way out. Pay up is the uncomprehending recommendation of the creditor - almost by definition that is not an option.
I do look very suspiciously at analogs between domestic finance and national economics, but in this case the four do seem still to apply - with a bit of a twist. Private debt can be offset in the totalizing process by hoarded cash. Mortgagees walking away is the easy and obvious way to sort some of the problem - and it doesn’t really matter which category you put that transaction into.
Unless as a nation we have stuff to sell and we go out and sell it, we have to work our way out.
It should to be wealth creating work. Filling in one newly dug holes and other zero-sum activities might give the impression of purposeful activity, but they won’t get the debt down - unless they redistributed hoarded wealth to pay down the debts. Not what the 1% is noted for.
Larry Jones
Jan. 24, 9:44 a.m.
It’s hard to accept their premise that the US is “working out of debt” when we hear the news of dire economic conditions in America: high unemployment, and extraordinary borrowing and spending by the public sector. My ‘gut’ tells me that the basic premise of the report is wrong. It’s almost as if it was written as a propaganda piece, to calm the populace and/or to justify high public sector spending. Their conclusions don’t appear to be backed up by real data. Some examples of statements in the report follow, with my comments:
1. “US households have made the greatest gains so far.” But not by ‘working out of debt’: of the ‘gains’ that we have made, 2/3 of that are due to defaults on home loans and consumer debt. Yes, household sector debt may be reducing, but isn’t this just being transferred to the private financial sector (and, in some cases, to the public sector) as continuing debt?
2. Exhibit 1, Ratio of Household Debt to Income, showing a trend line from 40% in 1955 to 100% in 2013: we’re expected to be comforted by the fact that we ‘may’ be returning to this trend? Is this what’s meant by the report title, “Working Out of Debt”?
3. As Exhibit 2 indicates, the US is closely tracking the Swedish experience. I believe that it’s a mistake to expect the deleveraging results in America to ‘closely’ track historical Swedish data - there’s no basis for that; UK households, for instance, are said to “not appear to be following Sweden….” How much of the Swedish history, for instance, was from defaults on home loans and consumer debt? We’re not given any data. Even now, the US curve is departing from the Swedish history.
4. Exhibit 4, Average of Relevant Historical Deleveraging Episodes: again, we’re given Sweden, with Finland thrown in. They retrace their steps by stating, “No two deleveraging economies are the same, of course.” That’s almost the same as saying that this data may not be ‘relevant’ (though it is claimed to be). Why even show the data? America is in a much worse condition, and future liabilities are not even considered in this report. However, they will be causing a considerable impact in the future.
5. Deleveraging: Where are we now? In the original report, the legend for the plot “Exhibit 1”, an expanded version of the plot shown here, “Domestic Private-and Public-Sector Debt as % of Country GDP, Q1 1990 - Q2 2011” included a list of “Change, percentage points” numbers: for the US: 2000-08, 75; 2008-Q2 2011, -16. This would seem to imply that we’ve reduced our debt by 16% since 2008. However, the values in terms of ‘Debt as a % of GDP’ have gone down from 296% to 279%, for a change of 5.7% in terms of a change in the curve. They have left these numbers off of the curve shown in the shortened version, to their credit (as they add to the confusion).
6. The ‘Composition of Debt’ as shown by Exhibit 2 of the original report only shows current levels for public-sector debt: for the US, 80% of GDP. Details are given for private-sector and household-sector deleveraging, but historical data for public-sector debt is not given. This seems odd, as it’s the largest concern for most Americans.
7. In the Appendix of the original report, Exhibit A1 states that their definition of ‘debt’ excludes “Loans from one branch of government to another”. Can this be the explanation for the seeming disconnect between the reassuring title of the report and the evidence of woe that we feel by our current economic condition?
Humpty Dumpty
Jan. 24, 9:36 a.m.
The Government has pumped ~ $5 Trillion of deficit spending into the economy since 2008 with many more trillions in works..what happens if that has to be scaled back…or…God forbid…has to stop…
Can the deficit spending continue at the current rate (or more), for how long, and what happens if it doesn’t….very important questions…why was this not discussed?
Jack Hayes
Jan. 24, 9:06 a.m.
I remember that Capital One entered the UK market just before 2000. The supporting rationale was that the UK was ripe for an expansion of consumer debt. Judging by these charts, it appears that COF was spot on with its prediction.
Clive Jones
Jan. 24, 8:18 a.m.
The UK always shows up high on the corporate (private sector) debt measure. Generally however domestic (UK) corporate debts have been in decline. Unlike the other G7 countries the UK has many companies registered in London, but that actually do little/no business in the UK and that have large debts such as RIO, AAL etc.
The other factor is that the UK’s response to financial crisis is typically to devalue by issuing more debt (sell more Gilts) and let FX take care of the problem.
Alex M. Swoboda 18323
Jan. 24, 1:15 a.m.
supercycle or not
the big question is, whether debt to income really remains on a longterm upward slope - if not, the deleveraging would take far longer or get more painful.