Despite all the anguished talk of collapsing credit markets, lending to individuals continues to grow. According to the last Bank of England data, in July lending went up ₤84 million compared to a year ago – a 6.2 percent increase. Of course, new mortgage approvals have slowed dramatically, pulling the plug on housing market. However, remortgaging activity is holding up comparatively well, while credit card debt is still increasing, albeit at a more relaxed rate. If individuals are still piling on the debt, why is there so much concern about a credit slowdown?
The problem is not the growth rate, but the level. After a decade of unfettered borrowing, households now owe a back-breaking ₤1.4 trillion to the banks. This is equivalent to about 100 percent of GDP, and it is up 186 percent since the first days of New Labour. We are not talking small insignificant numbers here.
Debt has become the primary source of economic growth. Like a dog chasing its own tail, more debt meant more spending, which kept the economy growing, which in turn, facilitated higher debt levels
As the debt stock spiraled upwards, the UK economy’s vulnerability to a credit slowdown increased. Before the credit crunch, personal sector lending was growing at between 10-15 percent. Now it is down to 6.2 percent. It didn’t take much of a slowdown to send the UK economy sliding towards a recession.
What do they want?
During the last 12 months, one over-riding objective has dominated UK economic policy; sustain credit growth to prevent house prices from falling. The Bank of England cut rates twice, and introduced a special liquidity scheme. Darling just launched a housing rescue package that envisages interest free loans and efforts to reduce repossessions.
This raises a perplexing question; what kind of credit growth rate are they looking for? Would the BoE and Treasury like to see a return to double digit growth rates of personal debt? Even they must recognize that there is a ceiling to how much debt people can absorb. The UK must be extremely close to this ceiling right now.
This “keep the credit flowing” strategy has no sensible, orderly terminal point. If consumers stop borrowing; the economy falls into the recessionary pit. If consumers keep borrowing, the day of reckoning is delayed, but the magnitude of the crisis grows.
The vulnerable state of UK banks is another worrying factor. As the economy slows, household default rates will soar. A recession could quickly metastasize into a banking crisis. Banks simply do not have the capital to absorb a serious economic downturn.
Start downsizing the debt
Ideally, the UK needs some kind of orderly reduction in household debt. Household balance sheets need to recover. In order for households to reduce their debt levels, they need to save more. This means consuming less. It is hard to see how this could happen without a significant downturn.
The UK has become grotesque debt dependent economy, facing the fact that it has to kick the habit. However, rehab will be a tortuous experience, but the sooner we enter the clinic the better.