HAVING narrowly escaped recession last year, home-buying Britons and free-spending Americans are taking on more personal debt than ever before.
But analysts are now starting to ask how consumers will cope as the two economies begin to recover this year, and as interest rates potentially start rising again from current record lows.
The Bank of England has cut key rates over the past 12 mo
nths to 38-year lows of four per cent and the US Federal Reserve has slashed them even further - to 40-year lows of 1.75 per cent - to shore up growth by boosting domestic confidence and demand.
However, central banks are going to have to be very careful how they tighten credit, say experts, including Stephen Lewis, chief economist at Monument Derivatives trading firm.
"The crunch will come when interest rates have to go up. The risk is that too much tightening could plunge the economy into recession before it has really got going."
Using credit and mortgage equity - borrowing against the value of houses - consumers helped British growth along at a steady pace last year.
Household debt as a proportion of disposable income surged to above 100 per cent in both countries at the end of 2001, from 90 per cent in Britain and 80 per cent in the United States at the end of 1996.
Debt ratios are probably the highest ever recorded in the two countries, says Michael Hughes, chief investment officer at Baring Asset Management. "That obviously is a focus of policy and of some concern. But there are positive and negative features," he added.
ONE positive aspect of the borrowing trend is that a large part of many people’s debt is a home loan, which is covered if the value of the house is greater than the mortgage. And because very often today both partners work, more debt can be supported comfortably.
The negatives are that a lot of debt has been taken on by people who have a limited number of years’ earnings to repay, warned Mr Hughes: "Many are in their late 40s and 50s, many are low-income earners."
In two cultures where share ownership is more widespread than in continental Europe, the collapse of stock markets has also left many people with losses. Many younger Britons are also carrying large credit card debts, which if a credit crunch comes could end in bankruptcy for some.
Credit-card lending in the UK as a proportion of total unsecured lending was nearly 30 per cent at the end of last year, compared with around 19 per cent in 1993.
"Governments have intervened by forcing greater disclosure [by banks of what the loans entail]. But governments can’t save people from themselves," added Mr Hughes.
One thing which saved Britons in the past was inflation, which in the 1970s and early 1980s was often higher than interest rates and helped cancel out some of their debt.
Now with price pressures in the UK - and Edinburgh especially, where prices are racing ahead at nearly 13 per cent a year - the chances of inflating your way out of debt are very low, analysts said.
Another problem with lower inflation is pay awards are also subdued.
" Debt growth rates at these levels can’t continue in the long term because income growth is much lower," said Steven Andrew, economist at Royal & Sun Alliance insurers.
"You end up with more debt than you have income to service that debt. It’s questionable how important the stock of debt is, provided the servicing of that debt is manageable. But once the cycle turns, the more highly geared you are, the more sensitive you are to changes in interest rates."
The credit boom seen in the UK has bypassed Europe’s biggest economy Germany, where household debt to income is just over 80 per cent and debt acquisition including home loans comes at a later stage in a person's life, economists said.
HOWEVER in France, where demographics in some respects resemble the UK, credit expansion has been a feature.
In the eurozone, overall levels of personal debt have not really changed in recent years so it will be able to better withstand interest rate rises than the UK.
Many home loans across the 12-nation zone are fixed for long periods and credit is not as easily available. Even if interest rates at 3.25 per cent were to rise, the effect would be muted, analysts say. Spare a thought also for those further east. Japan, in recession for the third time in a decade, is a textbook case of personal debt-overload, economists add.
Japanese household debt is estimated at more than 150 per cent of disposable income and domestic demand is frozen because people are trying to repay.
There is a massive debt problem in Japan. "The people there have loaded up with debt since the early 1990s," says Adolf Rosenstock, head of European research at Nomura International securities. "Inflation has disappeared altogether and is sometimes negative, and rates are zero.
"There seems to be no way out and falling asset prices create a vicious circle - that is the danger of debt explosion. Elsewhere [in the world] the crunch will come slowly year upon year. Let’s hope it is seen before it’s too late."
The full article contains 904 words and appears in Edinburgh Evening News newspaper.
