The Bank of England’s statistics on consumer credit paint a worrying picture for policymakers considering interest rate hikes. Here’s why.
Credit where credit’s due.
Consumer credit – which is lending to individuals not backed up by an asset such as a house – grew at a rate of 9.5% in December. This is an increase on November’s figures, but to be expected given the increased spending seen at Christmas. Overall, there has been a broad decline in rates of consumer credit growth since the start of 2017.
December also saw a significant contraction in rates of secured lending to individuals – loans that are based on assets which can act as collateral, mainly mortgages. Approvals for both purchases and remortgages were the lowest they had been since January 2015.
Whilst credit growth is slowing down, the stock of household debt is still very high – about 140% of household disposable incomes in total, compared to a peak of 156% before the crisis.
A significant factor behind these increases in household indebtedness has been the stagnation of wages seen since the financial crisis. Policymakers are fond of informing us that employment is extremely high, but what they neglect to mention is that Britain has seen the longest period of wage stagnation since the 1860s. Real wages have now been falling consistently for eight consecutive months, and this year the UK is set to have the worst record on wages of any OECD country.
In the absence of much real investment on the part of businesses or government, the UK’s recovery – if it can be called that – has rested primarily on the expansion of private credit. Even before the financial crisis UK households were holding historically high levels of debt, and have not had the chance to pay it down since. This means continued growth in household debt is just adding to the problem that contributed to the financial crisis in the first place.
In fact, it is this phenomenon – private indebtedness – that explains both the financial crisis a decade ago, and the crisis we are currently sleepwalking into. Whilst the slowdown in the rate at which credit is being issued might be taken as a good thing, the combination of high household debt levels and a slowing rate of credit growth is a lethal combination.
The debt deflation cycle.
When a small segment of the population owns the majority of the assets, the rest of the population is forced to borrow these assets at a cost. This cost, whether interest on borrowed capital or rents on borrowed property, is an ‘economic rent’ – unproductive, unearned income derived from asset ownership. Debt interest payments, for example, are just transfers of wealth from those without assets to those with assets — they do nothing to increase economic output.
If the ownership of assets becomes highly concentrated, more people are forced to spend more of their money on these interest payments, which sucks income up from the poor to the rich. Economies characterised by this dynamic have been termed ‘debt zombies’ by the economist Steve Keen. They are saddled with higher and higher levels of private debt, meaning servicing that debt starts to take more and more money out of the real economy.
But the party has to stop some time. Eventually, the private sector becomes so indebted that it has to stop borrowing, leading to a large contraction in demand, which can develop into both an economic and financial crisis.
The coming crisis.
The recent slowdown in credit is a sure sign that a recession is coming. In our low-wage, low-productivity, low-investment economy, any slowdown in private credit inevitably has a significant impact on consumer spending. This slowdown in consumption, which represents by far the most significant component of demand in the economy, then starts to hit businesses, which then invest less, creating contagion that spreads to financial markets and the real economy.
The slowdown might come sooner than expected if the cost of borrowing starts to go up. With inflation high as a result of the devaluation of the pound, the Bank of England is now hinting that it is going to increase interest rates. This will mean even more income is sucked out of the real economy for debt servicing, and may even lead to some consumers starting to default.
The economists at the Bank of England have warned that high debt levels represent a threat to the stability of the economy. They have pleaded with the government to spend more so that there is less pressure on individuals and businesses to keep the economy afloat.
But the government has ignored them. Instead of using public investment to support demand, improve productivity, and increase the long-run potential of the economy, this government has relied on cheap private credit to keep the economy afloat.
With households now more indebted than ever, and with the threat of interest rate rises on the horizon, the government now has no choice but to dramatically expand its own spending. In the likely scenario that it fails to do this, the next crisis will erase even the minimal economic gains of the last ten years. And it is the poorest who will suffer the most.