Posts Tagged ‘Disposable and discretionary income’

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It’s an odd thing, isn’t it? Not so long ago, people were talking about Belgium as being the country in northern Europe that was most in danger of going the way of Spain, Portugal and co. And for a long time, Holland – along with Germany and Finland – had been lecturing the rest of Europe about the need to live within one’s means. All of a sudden it looks a lot different. Holland is fast becoming the sick man of northern Europe, and the reason? Well, let’s hope George Osborne is paying attention, because it is a lesson he could do with learning.

According to data out recently, the Eurozone is out of recession. The German economy grew by 0.7 per cent, France by 0.5 per cent, and at face value it was encouraging stuff, but among all that good news there was one piece of worrisome news. The Dutch economy contracted by 0.2 per cent. It was not really a surprise. It contracted in the last quarter too, and the one before that and before that. In fact the country has been in recession for 18 months now. That makes this one nasty recession, but just remember, it was also in recession in 2008/09, so for Holland it has been a double dip of truly unpleasant proportions.

The reason is not rocket science.

During the boom years Dutch house prices rose too high – way too high. Seduced by the idea that owning a house in Holland was a sure-fire investment winner, sucked into the narrative that a shortage of land meant that house prices across the Netherlands were guaranteed to rise, urged on by a government that subsidised mortgages, the Dutch borrowed against their home, and borrowed against the belief their home would rise in value and they ran-up huge debts.

It really is a puzzle. Among those who lecture us the most about the need to live within our means – so that is Dutch and British finance ministers for example – there seems to be a kind of casual disregard for household debt. We must live within our means, unless that is to say you are a voter, in which case, borrow, put it on the plastic – it matters not, your home will rise in value.

According to OECD data, household gross debt to gross disposable income in the Netherlands is 285 per cent. This is the highest ratio across the OECD. To put those numbers in context, the equivalent ratio in the US for 2008 was just 108 per cent. In the UK the ratio is 146 per cent – which most would agree is worryingly high – and yet the UK household debt levels seem like prudence personified compared to those of the Dutch. Dutch house prices fell sharply in the first quarter of 2013, in 2012 and 2011. Yet despite the falls, Dutch house prices to incomes are still above the average for the country – although admittedly not by much.

Government debt is not so bad. Gross government debt is 71 per cent of GDP, net debt just 33 per cent, which is the lowest among the Eurozone’s bigger economies. Holland’s government appears to be in love with the idea of austerity; of prudence keeping government debt under control.

Yet consider what might happen if households find they just can’t afford their debt. Imagine what might happen if global interest rates rise, which they are likely to do over the next few years. If households find they cannot pay their way; if there is a surge in the number of properties repossessed by the banks, the chances that Holland will experience its own Northern Rock type moment seems real. The possibility of a Dutch banking crisis is very real. Yet the consensus among economists towards Holland seems to be one of relaxation. The country still boasts a top notch credit rating, for example.

The thing about austerity is that it matters not how prudent a government is, how clearly it balances its books (not that the Dutch government is balancing its books), when households run-up debts, and house prices crash, household debt can become government debt. This is what happened in Spain two years ago. It may happen in Holland, and may well happen in any country where the government tries to stimulate house prices, creating consumer confidence, in turn creating growth. Are you listening Mr Osborne?

© Investment & Business News 2013

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The threat posed by debt just won’t die down. Last week we reported that the Bank of England’s figures suggest that the UK cannot afford much higher interest rates. New figures from the Resolution Foundation suggest that the situation is even worse than the Bank of England suggested.

“If interest rates rise 1 per cent,” said the Bank of England in its latest Financial Stability Report, “households accounting for 9 per cent of mortgage debt would need to take some kind of action — such as cut essential spending, earn more income (for example, by working longer hours), or change mortgage — in order to afford their debt payments if interest rates rise…If interest rates rise by 2 per cent,” continued the Bank, “ditto, except that that it will be households accounting for 20 per cent of mortgage debt who will be so cursed.”

The Resolution Foundation has also taken a look at the story of the UK’s household debt, and its conclusions are even more disturbing.

Before the crisis of 2008 household debt across much of the developed world was worryingly high. Some countries, such as Denmark, Ireland, the Netherlands and Norway had it worse. Nonetheless with a ratio of household debt to gross house disposable income of 174, it was worryingly high in the UK. The good news is that it has since fallen, and the ratio at the end of 2012 was 146.

Alas, according to estimates from the Office of Budget Responsibility (OBR) it is set to rise again – not by much, for sure, but any rise is worrying. The OBR does in fact project that there will be a household debt to disposable income ratio of 151 by 2017 . To put that in context the ratio was just 112 in the year 2000. In the US, at the end of 2012 the ratio was 106.

According to the Resolution Foundation, at the end of 2012 no less than 3.6 million households were spending more than a quarter of their disposable income on debt repayments. Debt levels, however, are expected to rise as the government attempts to kick life into the UK housing market by encouraging greater mortgage lending.

But in its most recent report the Resolution Foundation looked at households whose debt repayments make up more than half of disposable income, or those in so-called debt peril. Right now, around 2 per cent of all households are in this position. If things carry on the way they are supposed to, and rates rise in line with Bank of England projections and real wages increase in line with projections for GDP, the Resolution Foundation estimates that the percentage number of households in debt peril will rise to just under 3 per cent by 2017. This is similar to the level seen in 2007, in fact.

If rates rise by 2 percentage points more than expected, the foundation estimates that the percentage number of households in debt peril will rise to 4 per cent. If, in addition to this, wages fail to rise with GDP, but rather – as has been the case in recent years – increases in wages continue to be outstripped by inflation the Foundation estimates that the number of households in debt peril will rise to 5 per cent.

Okay, you might say, but if this is the case then the Bank of England may not let interest rates rise. Unfortunately, central banks may have less say over the matter than is generally thought. See: The Great Reset 
There are all sorts of combinations and permutations.

But the points to remember are these: as rates rise in the US, the Bank of England may be forced to either up rates, or let the pound fall. If rates rise, debt levels in the UK will increase. If the pound falls, inflation will pick up, real wages may fall, and once again debt to income may fall.

In short, we may be in big trouble whatever happens.

But just bear this in mind. Debt does not matter if the percentage interest on debt is less than the percentage increase in income. What the UK really needs is for incomes to rise, and for this to happen it needs improving productivity, which comes from more investment.

© Investment & Business News 2013

The rich get richer and the poor get poorer. It sucks, but that is the way of the world. At least that is what most of us assume, but data from the ONS out this week suggests this may be wrong.

Since the start of the economic downturn in 2007/8 the richest 20 per cent of households have seen disposable income fall by 6.8 per cent, the poorest 20 per cent have seen income rise by 6.9 per cent.

It is important that we point out what we mean by disposable income at this point – it’s after taxes and benefits. The ONS has included VAT in the equation, by the way.

In 2011/12 the richest 20 per cent – before taxes and benefits – enjoyed income of £78,300, which is 14 times greater than the poorest fifth, which had an average income of £5,400. That is a ratio of 14 to one.

But take into account taxes and benefits and things look different – very different. The top 20 per cent saw disposable income fall to £57,300, while the bottom 20 per cent saw it rise to £15,800. The ratio changes to just four to one.

So what a bunch of socialists the government of the last few years has been. Except they haven’t really.

For one thing, the data does not tell the full story. It does not tell us about average income in the top 1 per cent quartile.

Besides if you drill down, things look different. If you look over a much longer time period, say from 1977, a quite different picture emerges. Since 1977, disposable income for the bottom 20 per cent has risen by 1.93 per cent, and by 2.49 per cent for the top 20 per cent.

There is in any case a more noticeable gap between the top 20 per cent and the rest of the population.

Average disposable income for the second poorest 20 per cent was £21,373 in the last financial year, or 1.35 times more than the first 20 per cent. Average disposable income for the middle 20 per cent was £27,526, or 1.29 times the average for the second poorest. Average disposable income for the second richest 20 per cent was £34,437, or 1.25 times the average for the middle 20 per cent. And average disposable income for the richest 20 per cent was 1.66 times the second richest.

But then again, so what? Don’t the rules of numbers mean that the average of the top 20 per cent will always be much higher than everyone else for the simple reason there is no upper limit to the top 20 per cent. The lowest disposable income can be is zero, the highest is… well, it’s infinite. Instead let’s look at how things have changed.

Equivalised disposable income, by the way, means: “The total income of a household, after tax and other deductions, that is available for spending or saving, divided by the number of household members converted into equalised adults; household members are equalised or made equivalent by weighting each according to their age, using the so-called modified OECD equivalence scale.” See: Glossary: Equivalised disposable income

And by the way just one more point. The proportion of people in the bottom 20 per cent who are retired has fallen over this time period. . This is because retired households have seen incomes growing at a faster rate than those of non-retired households.

© Investment & Business News 2013

According to the OECD, US household gross debt to gross disposable income had fallen from 130.7 per cent in 2007, to just 107.9 per cent at the end of 2012.

According to the Fed’s latest US Financial Accounts, debt as a share of disposable income has fallen to 110 per cent, from 112 per cent at the end of last year.

At the same time US house prices have at last begun to rise, and both the Dow Jones and S&P 500 have recently hit all-time highs, which has pushed up the value of US assets. Paul Dales, Senior US Economist at Capital Economics, put it this way. He said: “The ratios of debt to net wealth and debt to assets have fallen to rates more in line with long-term trends.” He explained further: “Every $1.00 of debt is now backed by $6.30 of assets, whereas before the recession it was backed by $4.80 of assets.”

Okay, returning to OECD figures, US household gross debt to gross disposable income was just 96.4 per cent in 2000. So in comparison to that year, debt is still quite high. But the trend is clear. US households have seen their own balance sheets improve markedly.

When you think about it, the above data illustrates why the economy has struggled so much in recent years. Despite interest rates being at record lows, US households have engaged in some pretty drastic deleveraging. Economists who failed to spot the crisis in the making during the mid noughties, failed to grasp that US households had simply run out of puff, and that the combination of falling house prices and over indebtedness meant an extended period of readjustment was inevitable.

This adjustment may have a couple more years to run yet. But it is not unreasonable to assume that by the midpoint of this decade, the US consumer will be able to lead the US economy into a new growth period. In combination there are signs of companies moving their manufacturing back to the US, which is a trend that was predicted by the Boston Group some two years ago. Both Apple and Google, for example, have recently announced new products which, just like Bruce Springsteen, will be made in the USA.

In the UK we are seeing something similar, but on a smaller scale. UK household debt to income has fallen too. In fact it has fallen even more sharply than in the US, but then again it was much higher to begin with. OECD figures indicate that UK household gross debt to gross disposable income was 146 per cent at the end of 2012, around 25 percentage points down on the 2007 high, but still among the highest levels in the OECD. Maybe the OECD data is simply telling us the UK deleveraging process has longer to run. If the US will enjoy growth like it used to in 2015, maybe in the UK we will have to wait until, say, 2017.

But it is interesting to note that Tim Abbott, managing director of BMW UK operations, has forecast that the UK will be producing more cars than France by 2018, moving it into second place for car production in Europe.

So this is good news, albeit that the time frame is more stretched that we might prefer.

But good news can create bad news, and that is what the markets are worrying about. To find out why, read the next piece.

© Investment & Business News 2013