The shape of things to come is probably not ‘V’

Discussion in 'Economics' started by ASusilovic, Aug 20, 2009.

  1. So say Bank of America Merrill Lynch economists — and it’s all because of those debt-ridden US consumers.

    For years US consumers have binged on cheap credit and provided the demand needed to match China’s furious supply. The result was prosperity and growth. But it’s time now to stop looking to the great American buyer to take on yet more debt and haul the rest of the world out of the crisis — they have their own problems to deal with, namely deleveraging.

    In fact, the US household debt to income ratio is currently at 131 per cent, near its all-time high, but consumers are expected to deleverage significantly in the coming months. In ‘The deleveraging playbook’, a report out on Tuesday, BofA-ML economists led by Neil Dutta consider how much debt needs to be removed from balance sheets to get back to more sustainable levels.

    The report looks at two scenarios. The first is for the US household debt to income ratio to revert to its long-term trend of 115 per cent. Assuming no change in disposable income in real terms, this would require a reduction of $1,750bn of debt. The second scenario is harsher, and requires the ratio to return to 91 per cent, the average of ratios between 1990 and 2000. Assuming no change in disposable income in real terms, this would require a reduction of $4,350bn of debt. You can see the two scenarios in the chart below:


    A couple of sensitivity tables later, we learn that, assuming nominal disposable income growth of 2 per cent (roughly in line with long-term inflation), a 4.5 per cent decline in household debt would be required this year and next to return to the long-term trend expressed by the first scenario. A 15 per cent reduction would be required over the same period of time and assuming the same inflation rate in order to return to the 1990-2000 average.

    The report’s authors conclude (our emphasis):
    Either way you look at it, US households will remain mired in a period of balance sheet repair. And, the continued debt elimination necessary to reach a more sustainable household balance sheet means that the ability of the US consumer to lead the recovery on a sustained basis will be limited. This is why we do not expect the consumer to lead the economy out of the recession. This is also one of the risks to the view that the US economy is on the verge of a V-shaped recovery.