Americans have fixed their own balance sheets. Can they now fix the economy?
Economic downturns that follow a financial crisis tend to be very, very painful. That's because the bursting of a large debt bubble is followed by a long period of hunkering down, when everyone tries to repair their personal balance sheets. That means no spending and thus no growth. Historically, this process can take 10 years or more--hence the term lost decade.
Is that the situation in the U.S. today? You might think so, judging from the dismal growth and employment data coming out every month. But a chart released in June by McKinsey makes me think the picture could be somewhat brighter, and if that's the case, the credit will go to American consumers--not so much because they're spending but because they've been saving.
According to McKinsey's global-deleveraging scorecard, American consumers have taken the lead among rich countries in getting their finances back in order since 2008. Until then, Americans had steadily increased their debt loads for about six decades. By the time the financial crisis hit, we had reached household-debt burdens not seen in decades--about 129% of disposable household income.
Since then, we've done some major belt tightening. Our debt load is down 11% from its peak (compared with 4% in Spain and 6% in the U.K.). At this rate, we're on track to hit a historic trend level of household debt, a more sustainable 103%, by 2013--only five years after the financial crisis.
What's more, the housing market is picking up, and housing is a crucial part of the debt-and-consumption equation. As the most recent World Economic Outlook report from the International Monetary Fund laid out, housing bubbles result in much larger than normal contractions in economic activity, because so much of middle-class wealth--and so much personal debt--is tied up in housing. You don't even have to sell your house at a loss for this to have an effect on spending. The IMF report notes that homeowners with negative equity in their homes, even those who are still paying their mortgages, spend 30% less on home maintenance and improvements. And that belt tightening goes directly to the bottom line of any number of American corporations, from Lowe's to Pottery Barn to Walmart. Indeed, research shows that the majority of job losses in the U.S. since the Great Recession were due to lower consumer spending because of household debt, a decline that resulted in layoffs at U.S. firms. Paring back debt is the precursor to greater spending and greater growth.
Given that consumer debt is down and U.S. home prices are beginning to swing up, what does that mean for the economy? Will America prove itself truly exceptional and escape the double-dip recession that threatens Europe and the slowdown affecting the emerging markets? Optimists would say yes and point to Sweden and Finland, which went through similar banking crises and major economic contractions in the 1990s but recovered quickly and went on to years of strong growth as households repaired their balance sheets. "In those countries, household debt to income fell 30% from its peak. The U.S. has been tracking that trend line and is even doing a little bit better," notes McKinsey Global Institute director of research Susan Lund.