BLACKROCK: The US Deleveraging Story Is A Lie

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Tell a lie often enough and people start to believe it. For several years, media headlines have been filled with references to a “deleveraging,” or a reduction in the level of U.S. debt.

The narrative goes as follows: The U.S. was driven into recession by a housing bubble, fueled by excess debt. But over the past six years, the economy has been slowly but steadily reducing the debt burden. And like all myths, there is a kernel of truth. The U.S. financial system has indeed made significant strides in reducing leverage and U.S. banks are better capitalized.

But as for the broader economy, the unpleasant fact is there has been no deleveraging, as I’ve mentioned before. In fact, as revealed most recently in the latest revised gross domestic product figures (GDP), we’ve generally seen quite the opposite. Consider the following three points:

1. U.S. household debt remains high. Thanks to a significant write-off in mortgage debt, U.S. consumers have modestly reduced their debt burden. Still, by most measures, household debt levels are still too high. The past several years have witnessed a huge surge in student and auto loans. And overall, U.S. household debt still stands at 103% of disposable income. While this percentage is down from its peak in 2007, it’s worth putting the number in perspective. Prior to 2002, household debt as a percentage of disposable income had never even climbed above 100%.
2. Fueled by cheap credit, corporations have been adding new debt. Since the third quarter of 2010, corporate debt has increased every quarter. Over the past six quarters, corporate debt has been growing at an average annualized rate of around 9.5%, well above the pre-crisis average of 7.5%.
3. Federal government debt has exploded. Outside of debt held by the Social Security Trust Fund, federal debt has risen by roughly $7.3 trillion over the past six years, an increase of 140%.

The net result is that during the period of so-called “deleveraging,” non-financial debt has increased by roughly $9 trillion. Even after normalizing for GDP, non-financial debt has actually risen significantly since the financial crisis. Six years ago, non-financial debt was around 227% of GDP. Today, it’s at a record 250%, as the figure below shows.

This leaves the question: Does rising non-financial debt matter for the economy and for investors? The short answer is yes, although probably not in the short term.

However, over the longer term, a high and growing debt burden has several implications for the U.S. economy: slower growth, a persistent headwind for consumers and vulnerability to even a modest rise in interest rates (this is particularly true for the federal government, where an improving fiscal picture has been flattered by artificially low rates).

In fact, the rising U.S. debt burden is one of the reasons why I continue to advise caution toward consumer sectors as well as why I have more modest expectations for long-term U.S. stock returns.

At a time when U.S. households are older and still struggling with slow wage growth, it would have been better had the country experienced a real deleveraging, rather than a cosmetic one.

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