One Step Closer: Public Sector Taking Deleveraging Baton from Private Sector
- The budget deficit has plunged; but government debt remains extraordinarily high
- Private sector deleveraging began alongside the financial crisis; and may be largely in its finale.
- Objective measures of household/consumer stress have come down markedly.
First, the news out of Iraq
A shorter term concern for the stock market is obviously what’s happening in Iraq and the impact on oil prices. Schwab’s Michelle Gibley addressed this on our internal call this morning, and we will provide updates as the news breaks; notably if it begins to have a meaningful impact on the market. As Michelle discussed, thus far, markets have taken the increased geopolitical risk in stride, but the turmoil could continue to put a bid under oil prices. Oil price increases could be contained, as fighting in northern Iraq doesn’t necessarily threaten exports from the south, which comprises 2.1-2.2 million barrels/day of the roughly 2.3 million barrels/day exported. Additionally, there remains spare capacity globally and strategic petroleum reserves (SPR), which could limit the impact of disruptions.
Sustained higher oil prices could weigh on global growth, but geopolitical shocks don’t tend to have long-lasting implications for most developed global stock markets. With that said, today’s report will address a longer-term concern with which we are all dealing, which is debt and the deleveraging cycle. Below is an update on government sector deleveraging, which is ostensibly just beginning; and private sector (household) deleveraging, which may be nearing its cycle end.
Debt and deficits are NOT the same thing
Let’s start by correcting what is often a misperception—elevated at times by what seems to be a lack of differentiation (or understanding perhaps) by politicians—that deficits and debt are interchangeable. In simple terms, debt is the cumulative effect of running consistent annual deficits.
On the subject of the federal budget deficit, the trajectory has improved markedly over the past few years, as you can see below. From a peak of over 10% of gross domestic product (GDP), the deficit is now less than 2.9% of GDP.
The decline in outlays (blue line above) has come partly thanks to sequestration; while the improvement in receipts (yellow line above) has come partly from higher tax rates, but also an improving economy. The decline in the deficit last year, in fact, was the greatest on record, as you can see below.
The rub is that these are baby steps; and although debt growth has plunged, it remains in positive territory (yellow line in the chart below). The level of public debt as a percentage of GDP remains near 100%, as you can see in the blue line in the chart below.
Surprising (to me anyway) is that there remain some economists that believe high and still-rising debt is not an impediment to economic growth. You can see clearly in the chart below that total credit market debt (every measurable form of debt, not just public debt) remains well in high debt zone. And as seen in the accompanying table, it’s still firmly planted in the zone in which the economy has had its weakest performance historically. This helps to explain not only this cycle’s anemic recovery; but relatively anemic recoveries generally since the early 1980s.
Households largely through deleveraging
Moving on to the private sector—specifically households—we see a much brighter picture. The most common way to measure households’ debt burden is to calculate it as a percentage of disposable personal income (DPI). You can see the clear improvement over the past several years in the chart below.
Notice I drew two trend lines on the chart above. The yellow one is a standard trend line; while the purple one is the trend line up until the debt bubble began to inflate in the early-2000s. I simply extended that out with the dotted line. Call that the healthier pre-bubble trend. As you can see, debt is now not only well-through the trend line; it’s now sitting on the pre-bubble trend line.
Couple that improvement with what is again a declining household savings rate, and it suggests that household balance sheets have improved markedly. I will concede that this improvement is not universal among households, and student debt is a notable exception; but the aggregate data shows that the household deleveraging cycle has largely wound down.
And, courtesy of low interest rates, the ability of households to service their remaining debt is quite “easy” historically, as you can see below.
In fact, the zone in which debt service sits presently, is the healthiest for economic growth, as you can see in the accompanying table above.
Finally, another key measure for household health is net worth, which has been running at an all-time high since the third quarter of 2012; and is now well above its prior pre-financial crisis high.
Let me conclude with my own proprietary chart showing an objective measure of stress on the consumer. It incorporates debt, various measures of inflation, job growth, home prices, and the stock market. Although stress has ticked up recently courtesy of some commodity prices, it remains relatively low historically.
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