Key points
- The GFC has ushered in a period of more cautious consumers in the US and to a lesser extent in Australia. Household savings rates are likely to be higher than over the last decade as households seek to cut debt ratios in the face of reduced credit availability, greater economic uncertainty and constrained wealth.
- This will result in a more constrained & fragile recovery in the US. In Australia consumer restraint is likely to be offset by mining sector strength.
Introduction
About 18 months ago a big concern was that the collapse in wealth, reduced credit availability and economic uncertainty associated with the global financial crisis would trigger a downwards spiral as households seek to repay debt and cut spending, causing a further fall in asset prices and hence wealth, triggering more efforts to cut debt, etc. In the event this was headed off by monetary easing and fiscal stimulus. But where does this leave us in terms of household balance sheets and debt levels? Will consumers go back to their old ways or remain more cautious going forward? This is not an issue for emerging countries, but is a big issue in the US and Australia.
Household debt levels remain high
The ratio of household debt to income remains high, particularly in Anglo countries. See the chart below.
Source: OECD, ABS, Thomson Financial, AMP Capital Investors
The rise in household debt levels prior to the GFC reflected: the increasingly easy availability of credit following financial de-regulation in the 1980s; falling interest rates which made debt more affordable; younger generations becoming more comfortable with debt as memories of serious economic problems faded; and rapidly rising wealth levels which reduced the need to save and supported a higher level of debt. This went hand in hand with a fall in household savings rates from around 10% of household disposable income prior to 1980, to around zero in both the US and Australia. As a result, consumer spending rose much faster than income did.
The GFC has sent most of these factors into reverse. Credit conditions are tighter, economic uncertainty has made consumers more wary of excessive debt and wealth levels have fallen. So pressure remains to reduce debt.
US households are leading the charge
Household deleveraging is well in train in the US. This is to be expected. Thanks to much lower share prices and a 20 to 30% fall in house prices the ratio of household net wealth to income is still 23% below pre GFC levels. Unemployment near 10% has led to far more cautious attitudes to debt and lending standards have toughened. Consistent with this household debt has fallen nearly 15 percentage points relative to household income from its high point in 2007. See the next chart.
Source: Thomson Financial, AMP Capital Investors
With the household savings rate running around six percent from near zero before the GFC, US households are continuing to pay down debt.
Source: ABS, Thomson Financial, AMP Capital Investors
Unfortunately there is no easy answer to how far debt levels need to fall. Debt levels have been rising ever since debt was first discovered. A simpler approach may be to focus on the saving rate. With US wealth levels unlikely to recover to 2007 levels quickly it’s likely US household savings rates may persist around current levels or even higher for some years to come.
This implies the world has lost the US as global consumer of last resort. From the early 1980s till recently US consumer spending grew faster than income (as the savings rate fell). This made it easy to reflate the global economy in tough times and there was a ready market for excess goods and savings from emerging countries.
However, it’s worth noting it’s not the level of the savings rate which matters but its change. The big drag on consumer spending and economic growth came as the savings rate rose from 2008 meaning consumption weakened relative to income. Having now adjusted to a higher rate of savings and debt reduction, consumption can move more in line with income going forward even if US consumers maintain a circa six percent savings rate. This would mean slower US consumer spending growth than in the pre GFC era but not the contraction some still fear. Maintaining a six percent saving rate will result in a further reduction in household debt ratios. The Bank Credit Analyst (a research group) estimates if US households maintain a savings rate of 6% then in 3 to 4 years US household debt will have fallen from 122% of household income today to around 94%, which is where it was in the late 1990s. This would leave US household balance sheets in good shape, but of course the path to get there will likely be bumpy.
Australian consumers also cautious, but not as much
Anecdotes from retailers attest to a more cautious attitude on the part of Australian consumers. Australian consumers also indicate a strong desire to pay down debt.
Household savings
However the pressure is not as intense as in the US. The ratio of household net wealth to household income, having recovered sharply from its GFC low, is now down by only 12% from its pre GFC peak. Unemployment is just 5.1%. And Australian’s don’t seem to be having much trouble servicing their mortgages despite much higher mortgage rates in the US – non-performing mortgages are running around 1% compared to around 8% in the US. Consequently, Australian households have been less concerned about paying back debt, compared to their US counterparts. As a result household debt has essentially gone sideways relative to household income over the last few years. See the next chart.
This has meant there has been less upwards pressure on Australia’s household savings rate. After a brief spike last year it has since fallen back. See third chart.
Source: RBA, ABS, Thomson Financial, AMP Capital Investors
Consumption has also been less exuberant in Australia, averaging 57% of GDP compared to 70% in the US.
Source: Thomson Financial, AMP Capital Investors
The mortgage equity withdrawal phenomenon – where households borrow to finance spending against the rising value of their home – was also less significant in Australia. Rather the increase in debt was largely focused on housing as increased debt enabled Australian’s to trade houses amongst themselves at ever higher prices.
This leaves much riding on the sustainability of high Australian house prices. If they tumble as in the US then the loss of wealth would likely impart significant upwards pressure on the household savings rate in a desire to reduce debt levels, resulting in significant weakness in consumer spending. On this front our view remains that while Australian house prices are significantly overvalued, the absence of widespread speculative demand and investor participation, slower growth in housing debt and a serious undersupply suggest the housing market is not in a bubble. In the absence of much higher interest rates, much higher unemployment or a huge increase in the supply of land – all of which seem unlikely in the near term – it’s hard to see a collapse in house prices. Which suggests that while growth in consumer spending may remain constrained it is likely to be reasonable.
One dampener though is the need for consumer spending to be constrained to make way for a likely boom in mining investment. Higher interest rates along with the surge in utility charges is likely to ensure that this will be the case.
Concluding comments
Over the last decade real growth in consumer spending in Australia averaged 3.5% pa, which was above average GDP growth of 3% pa. Going forward it is likely to average 2.75% pa, with rising spending on health, education and utilities likely to see slightly weaker growth in retail sales.