13 May 2013Asset managementEveryone argues about debt and deleveraging, but theuniversal conclusion seems to be that there is too much debtand not enough savings. Unfortunately, this is preposterous.It is like saying that there are too many people having theirhands shaken and not enough people shaking other people’shands. One person’s debt is another person’s savings.When you deposit money in a bank, you are lending moneyto the bank; your savings become its debt. The bank thenlends that on to others, creating another level of debt andsavings. When you buy a treasury bond you are lending tothe government. When you buy shares in a company youare effectively lending money to the company (repaid individends and part ownership). Ultimately, all that money isused somewhere. It may not be used in your own country butthen it could pass to another country. In the global economy,savings will be equal to investment. In the same way, totalstock of financial assets will equal financial debt.Debt is in fact a good thing in general; it allows the worldto function the way people would like. In other words, debtfacilitates an efficient allocation of resources. Debt allowsyou to smooth your income and purchase a home; it allowsentrepreneurs to access capital. Debt allows governments tocushion the impacts of recession and invest in infrastructure;it allows poor countries to borrow from rich countries.Debt becomes a problem when the underlying asset ismispriced, because the mispricing leads to a resourcemisallocation. Misallocation takes many forms: mortgagestoo big to be paid off, too much capital invested inparticular sectors (such as dot-com stocks), insufficientsavings in pension funds, ever-increasing government debt.When resources are misallocated an economy will growmore slowly or even shrink.The US consumer has been the poster child for runawaydebt, bingeing on mortgages and cheap consumer credituntil the bubble burst. But households in the US have madebig progress in deleveraging. Debt has now fallen from over140% of disposable income down to just over 110% (seechart 1). But surely the US consumer has more deleveragingto do, and surely this must mean slower growth. Well, justas importantly as the fall in the level of debt, the burden ofservicing that debt has fallen even more dramatically. As ashare of disposable income, interest and principal paymentson debt have fallen from a peak of 14% of disposableincome to a bit over 10%. Those interest rate cuts by the Fedare clearly having some impact.
Senior Fixed Income EconomistUBS Global Asset Management email@example.com
Fixed Income EconomistUBS Global Asset Managementgianluca.firstname.lastname@example.org
Source: Federal Reserve
Chart 1: Room service
Household debt service payments (interest and principal) as apercentage of disposable income
60708090100110120130140150Debt service (lhs) Debt to disposable income (rhs)
The universal conclusion seems to be that there is toomuch debt and not enough savings. This is preposterousas one person’s debt is another person’s savings and, inthe global economy, the total stock of financial assets willequal financial debt. It is easy to see how the transitionfrom leveraging to deleveraging led to a recession but thisdoes not explain why growth has remained weaker since.As banks and other financial institutions work to repair theirbalance sheets, are they properly intermediating betweensavers and borrowers and facilitating an efficient allocationof resources?