If there is one axiom of today’s Pigovian pessimism it is the idea that after decades of decadent reliance on debt to goose up consumption, US consumers are structurally over leveraged. And that it may take a decade or more of pain to unwind the damage, during which time US consumption and GDP growth will be pitifully slow.
Arguably this is the most overbought idea to come out of the current crisis:
Everyone is by now familiar with the first chart below, but few know the second one, which we find much more informative.
Essentially it shows that, although leverage ratios increased in the Greenspan era for all income groups, it is really only the bottom 20% of the income distribution who have clearly borrowed more than they can afford to service. And it is these higher income groups who account for 90% of US consumption. So the debt issue is arguably as much or more a major social and political problem as an economic disaster.
One reality check we like on affordability is the proportion of disposable income absorbed by all non-discretionary payments including debt service, food and other shelter and transport costs. When oil prices were at their peak this ratio was starting to look uncomfortable, though not as bad as in the 1980′s recession. Now it is in the bottom third of its range over the past 30 years or so.
A quick return to those oil price levels would clearly be a body blow, but in our view would itself depend on global GDP growth soaring straight back to 5% or more.
Simpler still is to ask yourself whether the average mortgage banker would be appalled by a middle class couple with a decent job applying for a mortgage of 1 ½ to 1 ¾ times their household income? Even today the answer is probably not.
One could usefully get a lot more granular than that, but the more interesting point is why we find it so emotionally satisfying to believe that US consumers have become irrationally and fecklessly over-borrowed when the facts don’t really live up to the caricature.
The debt story is really about the cyclical vulnerability of consumer spending, not a structural obstacle to future spending that matters even when income grows. The distinction is critical. Full recovery of consumer spending can occur with house price stabilisation and a return of income growth. It has little to do with getting the savings rate or debt-income ratio to certain levels.
Meanwhile, if aggregating across households is misleading, aggregating across broad sectors is even worse.
Jonathan Wilmot, chief global strategist at Credit Suisse Investment Bank, is blogging at FT Alphaville for the day.