Image: Flickr
Image: Flickr

The two biggest economies in the world are riddled with debt, should we be worried?

In the US, the big problem is household debt. In China, it’s largely related to both state owned companies.

In the US, household debt to GDP has moved close to the 2008 peak.   In the second quarter, total household debt rose by $35 billion hitting $12.3 trillion – compared to a $12.7 billion peak in 2008.   On the other hand, disposable income has risen since 2008, such that US household to disposable income is now 105%, compared to 130% in 2008.

In China, the International Monetary Fund (IMF) has waded in. James Daniel, the IMF’s mission chief in China said: “China’s medium term outlook is clouding because of high and rising corporate debt.“ He said that China must “urgently address” the problem.

In fact, China’s debt has risen to around 245% of its GDP, that is high, but not exceptional. It is just that in China debt has risen incredibly rapidly.  If history is any guide at all, China will suffer a banking crisis. There has never been an occasion when debt has risen so fast in a country over such a short period of time without a banking crisis following. Julien Evans Pritchard from Capital Economics said: “Investors are right to be worried; dealing with the unsuitable build-up of debt is one of the biggest long-run challenges that policy makers face.”

But the real problem in China, is that money has been thrown at inefficient companies, creating so called zombie companies. Going in China’s favour is that most of its debt is internal. China owes money to itself.   It is not exposed to international creditors the way the Asian tiger economies were in the 1990s, before the Asian crisis of 1997.  But, China is seeing a misallocation of resources. The problem may be largely internal, but it is still very serious, and may cripple the economy. Maybe China needs a form of 1980s Thatcherism, purging its system of obsolete businesses.

In the US, the good news comes in the form of low interest rates and the cost of servicing debt is close to a record low. So you might be tempted to ask, “what’s the problem, then?”

Capital Economics said: “Even if the overall level of household debt is manageable, however, one potential area of concern is how much of it is owed by sub-prime borrowers.” Then again, mortgage lending to those with the poorest credit scores is far lower now than it was in the mid-2000s. But a concern does relate to sub-prime car loans.  Capital Economics said: “Some, including the comedian John Oliver last week, have instead suggested that auto loans are the next unsustainable bubble. It is true that auto loan debt has been rising at an annual rate of around 10% for the past three years. Furthermore, lending to those with credit scores below 660 has been the fastest-growing segment of the market, and now accounts for around 35% of all new originations.”

However, it said that “Sub-prime auto loan origination is still lower than it was in 2006 and the caveats about higher incomes and lower interest rates apply here too. At $1,100bn, total auto loan debt is well above the previous peak of $820bn in 2006. But the current level of debt equates to 790% of disposable income, well below the 830% ratio in 2006.”

It concluded: “All things considered, the household debt figures provide little cause for concern.”

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