The great myth of the last few decades is that people can establish sustainable savings by investing in other people’s debt. That is how relatively astute and candid writers, such as Jeremy Warner for the Telegraph, can claim that “Britain is still a hugely wealthy nation” and actually mean it. In his latest blog post, Warner tries to convince us that aggregate private debt in Britain is not so bad when we factor in “assets” as well.
Last week I drew attention to a report by Royal Bank of Scotland, which argued that we were only about a third of the way through the process of household deleveraging – that is the reduction relative to income in household debt – and that continued adjustment in this regard would act as a significant drag on domestic demand for many years to come.
Well here’s the other side of the coin. Yes, household debt relative to income rose to unprecedented levels just before the bust and remains way above what RBS considers “sustainable”. Yet the point that is frequently forgotten is the asset side of the balance sheet, which as can be seen from the Office for Budget Responsibility table below, remains far in excess of the debt.
The physical assets alone (mainly housing) were last year worth 382pc of income. Add in financial assets such as pensions and other forms of saving, and the figure rises to 827pc of income, an excess over the debt of 667pc.
So first of all, as you can see, “net worth” in real terms has been steadily declining over the last few years and is projected to continue doing so – not exactly a stellar endorsement of Warner’s argument, especially if we safely assume the decline will be worse than expected. More importantly, though, the entire logic rests on the flawed premise that “physical assets” and “financial assets” are interchangeable with “savings” that can be used to pay off debt.
Since at least the early 1970s, this is what people in the developed world have been programmed to believe “savings” mean. The physical assets referred to above are mainly composed of housing, of which about a third (34%) is property owned outright without any outstanding mortgage. Already, we can see how it is tricky to include housing as an individual’s asset that can offset the burden of liabilities. As most people should be well aware after 2008, there is a high risk that property valuations will once again crash in the near future.
Since housing is a relatively illiquid asset, it could prove very difficult for people to actually convert home values into “savings” before they lose a lot of that imaginary value. Another problem with Warner’s argument is that he doesn’t provide any figures for how housing liabilities are distributed within the population. Warner briefly references this omission by stating the following:
The problem with all these numbers is of course that they are only aggregates. The reality is that of two nations – there are those with high debts and little in the way of assets, and those with lots of assets and little in the way of debt. This is partly an intergenerational phenomenon.
As a whole, the post war baby boomers and their immediate forebears are relatively well placed, with gold plated pensions and houses which are either owned outright or mortgages whose value relative to their houses has been destroyed by repeated bouts of inflation. It’s the next generation down that has all the debt.
That extremely simplistic break down takes us to the next egregious part of the argument, where Warner considers “financial assets” as assets/savings that can contribute nearly 500% to the net worth of British people relative to income. Basically, Warner is asking us to believe that money lent out to very questionable borrowers, which now takes the form of stock portfolios, government/corporate bonds and pensions, should be counted as liquid “savings” for the creditors/investors.
When we think about it that way, it should become obvious why the entire argument is ridiculous. Most of those “assets” are at a very high risk of disappearing into the black hole of debt deflation within the next few years, and therefore will not help these “savers” pay off their gargantuan debts. These people really have no idea where or what their money has been allocated or invested in and what the risks are associated with those investments. Yet, Warner believes we should factor them into “net worth” and allow the baby boomers to erroneously believe that they are much wealthier than they really are.
When we strip out all of this “financial asset” nonsense, factor in decreasing wages and job benefits, a prolonged period of modest inflation in necessities, ongoing risks of debt deleveraging (negative economic growth, increased unemployment) and untenable public deficits (higher taxes, less spending, higher interest rates), it becomes very clear that the average U.K. citizen is deeply underwater on his/her debts. And, therefore, that Britain is not still a “hugely wealthy nation” by any stretch of the imagination. In short, don’t believe for a second that all your “savings” held in debt instruments somehow make you wealthy.