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Dealing with the debt
We are now experiencing the longest recession since the 1950s. Interestingly there has been a recession roughly once a decade since then, but the cycle times of recession is the subject for a different blog. This week Dubai got me thinking about the part that debt has played in getting us here, and the role that debt will play as we scramble our way out of this rut.
Here in South West England the RDA economists reported high levels of household debt yet noted that businesses are less exposed. Is this good news or bad news? Let’s think about business first. There is a school of thought that says businesses are expected to carry some level of debt, even when times are good. If you buy goods for resale or raw materials for manufacturing then yes, you usually purchase on credit terms. Or if you are expanding you may have loans for capital expenditure, it’s all calculated and planned for in the business plan.
So what sort of levels of debt do service industries need to carry? This is arguably the largest sector in the region, a sector that isn’t based on buying goods for resale, a sector with lower capital expenditure requirements than might be expected in manufacturing. The size of debt borne by service industries is likely to weight the figures for average level of debt in the region. I’ll leave that one with you, but please don’t get me started on the cost of IT projects.
Now, household debt. The accumulation of household debt has made an invaluable contribution to three sectors: the financial services sector, the construction sector and the retail sector. All three of these sectors have suffered as the credit crunch has, well, crunched. But only one of these is structured to keep benefitting as the recession proceeds. The question is whether the returns are increasing or diminishing.
Yes, we know that the financial sector reaped what it sowed in selling mortgages to those who couldn’t afford them. Some of this loss will be written off no doubt. And yes, the current climate, with concerns about pay freezes, pay cuts and even job losses will have people trying to reduce their debt, possibly in the face of reduced means to do so. But it’s not as simple as deciding not to buy that shirt or that extension to the house. The very nature of compound interest means that you have to keep paying out, and the less you pay, the more you still have to pay.
It’s difficult to knock the accumulation of household debt if you ever championed the period of economic growth we’ve just enjoyed. The unprecedented and, as we now know, unsustainable levels of consumption are what made it possible. They were positively encouraged, by government on one side, peer groups on the other and a whole range of media in between. Dealing with the debt appears to be changing spending patterns, and consequently the structure of the economy. The question is - is this a complete behaviour change, inadvertently creating a green revolution, or will we be back on that boom and bust treadmill the minute we’ve forgotten the pain of surviving the recession – again?
Great article Sarah! I truly believe that we will be on that “boom and bust treadmill” as soon as all media hype about the recession becomes last nights fish and chip paper. As you mentioned at the beginning of the article, there has been a recession nearly once a decade since 1950 and I’m not sure that’s a cycle we are going to break.