Monday, November 12, 2012

Different Debt for Different Folks

Lewis’ snapshots of each country focus largely on a ‘national character’ that flavors the effects of the economic crisis in different countries around the world. His broad thesis is that bankers of all backgrounds and races gained exposure to the dangerously-easy and tempting opportunities afforded by American financial ingenuity (obscure financing tools created by investment bankers at the biggest, baddest Wall Street banks). Everyone was drinking the artificially sugary Koolaid, and for different cultural reasons as well. The promise of risk-free investments and credit that were ‘too good to be true’ turned out to play into the vices of everyone from the centuriey-old Icelandic fisherman to the spendthrift Greeks to the rigorously rule-based Germans.  

I found this attempt to tether economic outcomes to national character interesting, and did a bit of hunting for further macro data to support the conclusion that governments are, after all, simply extensions of the people and their devious (or responsible) money habits.

We see that rich Anglo-Saxons countries have racked up the title for most personally indebted nations, perhaps due to their desire to own homes and cars and everything else expensive there is. This affinity for debt is matched by high levels of government debt as well. Developing countries have remarkably lower rates of household debt, while our European friends straddle these debt extremes.

Household debt is not be conflated with fiscal irresponsibility; highly leveraged households, like firms and governments, are in good financial standing so long as they can comfortably pay back the debt with future revenue streams. However, these Western countries have not always stood at such precariously indebted heights, from the first quarter of 2004 to the first quarter of 2009, private-sector non-financial debt rose by an average of 43% of GDP in the western countries listed above, excluding Germany of course. The US, naturally, led the way as can be seen in the graph below, in which the green line is household debt and the red line is government debt, both indexed to population (blue line).
1952-2012: U.S. Government Debt vs. Household Debt

The private sector has now begun to deleverage, and we have seen the spread the debt to public balance sheets. Bail-outs, stimulus, and reduced tax revenue from recessions have made government debt ratios look rather scary of late. However, this movement of debt from private to public hands is a somewhat more sustainable and stabilizing trend. While governments can deal with high levels of debt through eventual taxation and growth, households do not have the same flexibility. Britain, for example, has maintained high levels of debt (exceeding 100% GDP) for 81 of the last 170 years.

While Greece and other Euro zone countries steadily increased household debt preceding the financial crisis, we can see below that Germany was not having any of it. While Germany's banks might have been duped, its households held fast to their principles and did not rack up debt like families across the Euro zone. Increases in household debt can entail high gains for domestic demand while they last, but often result in severe losses and debt recessions when this growth takes a turn, this helps explain why most countries on the graph below are in struggling, while Germany is doing just fine. The very high levels of debt in Spain and Ireland are largely explainable by their housing bubbles. 

Household debt-to-GDP ratio (%)

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