Debt Rules in the New Normal Economy
If a ‘new normal’ economy exists, it is defined by low inflation, low interest rates and historically high levels of personal debt.
The other day, I sat listening to two economists giving an update on the UK economy. I was reminded of the old joke: ask two economists a question, and you’ll get three answers. We asked a few; they gave us plenty.
As we sat there listening intently to these economists give their latest spin on the state of UK PLC, they talked about the current economic cycle representing a return to normality.
A New Normal?
What does that mean? I wondered. What exactly is the new normal and what does the new economic cycle look like. How does it compare to what we’ve seen before?
According to our esteemed economists, it apparently looks nothing like the ‘old’ normal. Gone are the days of simultaneous high interest rates and inflation (so-called stagflation – a word that has economists quaking with fear); and gone are the ‘boom and bust’ cycles that have characterised the UK economy so many times in the past.
But those are not the only differences. Today’s economy has a key defining characteristic, never before seen in the UK: low interest rates combined with record levels of personal debt, over a sustained period of years.
Now, I’m no economist, but it seems to me that there is no new cycle, that we’re not in a new normal. In my (literally) unqualified opinion, what we’re seeing now is brand new. We’re in uncharted territory.
Economists are rather like weathermen and women. All they can do is try to make forecasts based on the available data. It all seems quite finger-in-the-air to me, without much certainty. All the economists seem able to do is predict a range of possible outcomes. And just like weather forecasters, sometimes they’ll get it right and sometimes they’ll get it wrong.
So, were our two economist friends correct? Is the UK economy in a new normal? And if so, what does it look like?
1. Interest rates remain low - for now
First, interest rates remain historically low. The Bank of England base rate has remained virtually static, at 0.5% or 0.25% since early 2009, and there seems little chance of it rising much any time soon. That is, unless there is a major shock to the economy or to Sterling which causes them do so. Remember Black Wednesday in 1992? During that brief crisis, the base rate rose to 12% as the government and the Bank of England struggled to keep Sterling in the Exchange Rate Mechanism (unsuccessfully, as it turned out, largely due to the huge and infamously profitable currency speculation by George Soros and his hedge fund friends). John Major’s Conservative government never really recovered from that debacle, paving the way for Tony Blair’s New Labour movement that swept to victory in 1997. But I digress…
2. Inflation is not a threat - yet
Second, inflation remains very low. The CPI index, currently at 2.2%, has never exceeded 4.5% this century, and has stayed well below 3% for most of it. And with commodity prices also staying low, it looks interest rates will remain low for at least a while longer. Wage demands, however, may cause some inflationary pressure.
As usual in any upward part of an economic cycle, especially with a prolonged period of low interest rates, house prices continue to rise. In fact, UK property prices have been moving steadily upwards since the mid-1990s. According to Nationwide, the average house price today is around £230,000, compared to £62,000 in 1995, a rise of 271% in 23 years.
Properties these days are often being bought by speculators and investors as a commodity, not just as a home to live in. This has made it difficult for many people, especially young professionals, to get onto the housing ladder. Instead, many are left pushing their noses against estate agents’ windows, wondering if they will ever be able to afford a home in which to raise their family.
3. Personal debt is through the roof
And third, we have perhaps the biggest economic change of all: the enormous and unprecedented levels of personal debt carried by so many of us. Debt is cheap, and we have been hoovering it up. With apologies to Sir Winston Churchill, never in the field of economic history has so much been owed, by so many, to so few.
This normalisation of high personal indebtedness is indeed a new normal. It has been fuelled by student loans (estimated to exceed £1 trillion within 25 years), plus easy access to larger mortgages, credit cards, payday loans and more recently PCPs for new vehicles.
Of course, student loans are necessary to obtain the university education so many have benefitted from for free in the past; large mortgages are the only way for most people to get onto the housing ladder; and credit cards and other loans are often the only way that many people can manage to extend their salaries to meet their standard of living expectations; and car loans? Well, if your neighbour drives a nice new car every few years, why shouldn’t you?
So what happens next?
So what happens when low interest rates start to rise, which they surely will, sooner or later? Nobody really knows, but with many on fixed term mortgages, the impact is unlikely to be immediate. But when it does happen, consumers will likely be left with less money in their pockets. And maybe this will force them to continue borrowing on credit cards and various loans until they are maxed out. It’s not a very promising outlook.
What is certain, however, is that this ‘new normal’ level of personal debt places a lot more emphasis on wages and salaries. We’re now more exposed than ever to any changes in our income. Current concerns around changes to working hours, the reduction of overtime, zero-hour contracts and even redundancy, seem well founded.