Mental Midgets and Moral Pygmies
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December 10th, 2009 by Prieur du Plessis, Investment Postcards from Cape Town
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This post is a guest contribution by Niels Jensen*, chief executive partner of London-based Absolute Return Partners.
I have arrived at the fourth and final letter in our series about macro themes likely to shape the future. The topic this month is the role of the consumer; the fact that he has over-extended himself financially in recent years and the implications of that. Please allow me to start with a disclaimer: this topic is so vast that I cannot possibly cover every aspect of it. One area which I don’t touch on, for example, is the effect lower consumer spending will have on corporate earnings. Also, I fully accept that not all countries are as leveraged as the UK and the US; the following is predominantly a discussion about the Anglo-Saxon model. Accept the letter in that spirit and you should enjoy it.
Up to the neck in debt
It is really quite simple. The problem is leverage - leverage at every level of the economy. The consumer is up to his neck in debt, but so are our banks and our governments (or, at the very least, they soon will be). In the US (chart 1a), total leverage has risen from a post World War II level of about 150% of GDP to roughly 350% of GDP today with households and the financial sector responsible for most of that growth. Meanwhile, in the UK (chart 1b), total leverage has grown from 200% of GDP to a mind-boggling 500% of GDP in little over 20 years with households and financial companies also accounting for most of that growth.
Chart 1a: Total US debt as % of GDP
Source: Deutsche Bank
So, while it is true that governments on both sides of the Atlantic are currently taking on potentially dangerous amounts of debt, it is not quite true that they are behind the excessive creation of debt over the past few decades. If anything, they should be accused of naivety, ignorance and perhaps even stupidity for allowing the current situation to develop in the first place.
Midgets and pygmies
Now, why didn’t anyone see this coming? Why did our ‘midget’ leaders permit leverage to grow out of control? Well, as a starting point, it is important to understand that, from the consumer’s point of view, increasing leverage has been a logical response to the lower macro-economic volatility experienced over the past 25-30 years. As demonstrated by Dr. Woody Brock at SED (chart 2), household income has become much more stable in recent years with volatility on personal income being cut in half when compared to the 70s and by almost 80% when compared to the 40s. As a consumer, it is perfectly rational to increase financial leverage if you experience rising income stability. What is less rational is to take it to the extreme, as both US and UK consumers have done in the past 6-7 years (note how the slope of the US debt-to-income ratio in chart 2 steepens post year 2000).
Chart 2: Development of US household debt
Source: Strategic Economic Decisions, Inc.
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* Niels Jensen has 25 years of investment banking, private banking and asset management experience. He founded Absolute Return Partners LLP and is its chief executive partner.
Source: Niels Jensen, Absolute Return Partners LLP, December 8, 2009.
Dr. Prieur du Plessis is an investment professional with 26 years' experience in investment research and portfolio management. More than 1,200 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns, including his blog, Investment Postcards from Cape Town. He has also published a book, Financial Basics: Investment. Prieur is Chairman and principal shareholder of South African-based Plexus Asset Management, which he founded in 1995. The group conducts investment management, investment consulting, private equity and real estate activities in South Africa and a number of foreign countries. He also serves as Honorary Consul of Slovenia for South Africa, actively developing economic, cultural and scientific relations between Slovenia and South Africa. Prieur is 54 years old and live with his wife, television producer and presenter Isabel Verwey, and two children in Cape Town, South Africa. His leisure activities include long-distance running, traveling, reading, motor-cycling and scripophily. Read more from the author/contributor here.
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Tags: 1a, Absolute Return, Anglo Saxon, Consumer Spending, Corporate Earnings, Current Situation, Dangerous Amounts, Deutsche Bank, Executive Partner, Financial Sector, GDP, Governments, Growth Chart, Households, Leverage, Mental Midgets, Niels Jensen, Stupidity, T Touch, World War IiPosted in Markets |
