Monday, December 15, 2008

Urinating On Labour's Debt Bubble


That's what I call a bubble


[Warning - this blog has got quite long]

As our German friends reminded us last week, we Brits are currently perched atop a highly unstable - and rapidly deflating - debt bubble. They say there's nothing much we can do about it, and we'll just have to let nature take its course.

But Our Beloved Leader and his supporters beg to differ. He tells us there are things that can be done, and he's doing them. Unlike the evil do-nothing Tories.

So who's right, I wonder?

The first thing to understand is that our debt bubble is big. Big, big, BIG. As the chart above shows, our total debt - even excluding the balance sheet liabilities of our banks - has grown hugely over the last decade.

In the decade up to 1997, the combined debt of households, companies, and government increased from around 180% of GDP up to around 200% - up by one-tenth. But in the last decade, the one under prudent Chancellor Brown, it's grown from 200% to 300%.

This is Labour's Debt Bubble and it amounts to a staggering £2.5 trillion - ie £2,500,000,000,000. Which is £100,000 for every single British household.

And please grasp two key points about that gob-smacking number.

First, it's just the additional debt we've built up since 1997 - we already had £1.7 trillion of debt to start with.

And second, it excludes the debt of the banking sector. This extra £2.5 trillion relates just to the debts taken on by "Real World" entities like families, manufacturers, and the government. It does not include the further trillions of debt accumulated by our banks, whose total liabilities when last sighted stood at a pant-wetting £6 trillion.

So who's done all this borrowing?

The following chart shows how that £2.5 trillion (£2,500 bn) breaks down between non-financial companies, households, and government.


As we can see, companies, households, and government have all contributed. But the worst culprits have been households and companies.

Reckless household borrowing we all know about, so it's no surprise to find they borrowed practically £1 trillion over the last decade.

The massive £1.2 trillion borrowing splurge by companies might come as a surprise. After all, haven't companies been doing rather well for most of the last decade? Why have they borrowed?

The explanation is that in an era of cheap credit, companies have been deliberately gearing themselves up in order to boost the returns to equity holders - including of course, their own senior managements, and in many cases their private equity investors. That's been going on all over the world, but here in the UK, the whole trend was strongly reinforced by Gordo's notorious 1997 pensions tax grab, which not only robbed pensioners, but also had the effect of reducing the relative cost of debt finance to companies (see this blog).

And what about government borrowing? Judging from the chart, the government has been abstemious in the extreme, contributing "a mere" £320bn to the blow-out.

But the trouble is, that was borrowing in a boom, when government shouldn't have been borrowing at all. Now we're in a bust, future borrowing is set to rocket. Even the government now admits to a further £0.5 trillion over the next five years, and the true figure will be much higher still. BOM's fag packet says it could easily be £0.7-0.8 trillion (we'll be running our doomsday calculator again soon).

And all of these figures exclude the hundreds of billions of additional debt being taken on to shore up the banking system (the government's so-called "financial sector interventions"), they exclude the blanket guarantees given on £6 trillion of bank deposits, and they exclude all those other off-balance sheet Enron items like public pensions and PFI (see this blog).

So what happens now?

First, Labour's debt bubble will deflate - probably a lot - as households and companies put the brake on new borrowing and pay off existing loans. It's called deleveraging and it's already happening.

Second, the government's share will get much bigger as its borrowing explodes. And the more Brown goes on "doing something" - ie splurging taxpayers' cash around - the faster that's going to happen.

One effect will be to transfer the burden of debt from the profligate to the righteous (aka taxpaying savers - eg see this blog).

But the other effect - the one Brown bangs on about - is that it might cushion our economy against the slump.

Will it?

BOM is squarely with the Germans and the Tories on that one.

When you understand the sheer size of our debt bubble, you understand that even government cannot keep it inflated. £2.5 trillion of debt is way beyond the credit capacity of HMG (see many previous blogs).

Indeed, when you stand it up against the mighty deflationary wind roaring out of a busted £2.5 trillion bubble, Brown's much hyped £20 billion fiscal package really is pissing into said wind. And if you've ever tried such pissing, you will know that any immediate relief is soon followed by very cold wet legs and an irresistable urge to go again.

Treasury officials almost certainly understand this. They surely understand how bad the fiscal position really is, and realise we cannot sustain a meaningful reflation.

A painful adjustment is unavoidable, and we need government to keep its legs dry. If government succombs to the cold as well, we really will be in trouble.

PS Jeff D sent us a link to an interesting post on the US debt bubble. Under the snappy title Den of Liars, Karl Denninger lays into America's rulers for lying to the public about the extent to which US growth has been driven by debt accumulation.

He points out that the US accumulation of additional debt between 2000 and 2007 was $23 trillion, whereas the accumulated additional money GDP over that period only totalled $14 trillion. So the growth of debt exceeded the additional GDP by $9 trillion. And blowing off that froth, in some sense, real underlying GDP must have actually fallen. As he puts it:


"Taken-on-debt that is spent is not actual output expansion any more than I am "improving my wealth" if I go borrow $200,000! In fact I am damaging it because I must not only pay the $200,000 back I must pay interest as well!

That's right folks - we haven't had an expansion in GDP over the last eight years. Congress and its organs of reporting economic "facts" have lied. We have in fact actually seen about a 10% contraction in real GDP from 2000 levels; all of the so-called "expansion" of the Bush Administration has been a lie intended to prevent recognition and working through of the recession that should have happened in 2000."

And Karl has the following Debt/GDP chart to give us some historic perspective:

Now, we realise that the precise validity of Karl's GDP minus debt calculation is a little dubious, but the Big Picture is striking. So just for fun, let's apply his arithmetic to Labour's growth record.

Between 1997 and 2007, money GDP increased by a cumulative £2.9 trillion (ie summing each year's increase in GDP over the 1997 starting point); debt increased by £2.5 trillion; so GDP "net" of debt increased by £0.4 trillion. Which is at least better than the US result.

But even so, on this basis 86% of our 35% real GDP growth since 1997 was "debt funded". And if we were to "give back" all of that additional growth, our GDP would need to fall by over 20% from current levels.

Gulp.

(And to really buck yourself up, see this blog for how the ongoing implosion of financial services might impact GDP)

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