Sunday, June 25, 2006
Debt won't bring down our house of cards
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

The 40th anniversary of the launch of Barclaycard, to be celebrated this week, provides an excuse to look at credit and debt. Have credit cards oiled the wheels of the economy or just allowed us to sink deeper and deeper into debt?

The history of plastic cards in Britain is interesting. Barclaycard’s 1966 launch was preceded in the UK by Diners Club, 1962, and American Express, 1963. Both were charge cards - you have to pay off the amount in full at the end of the month - rather than credit cards.

Barclaycard, launched in an era of belt-tightening and sterling crises, did not have a huge initial impact, though it claimed 1m cardholders and a network of 30,000 retailers at the time of the launch. The other banks took until the early 1970s to follow with their joint venture, the Access card, but it took years before credit cards reached out to the population as a whole, being long regarded as the preserve of Cortina-driving executives with expense accounts.

A few days ago I was sitting next to Lord Howe, who as Sir Geoffrey Howe was chancellor of the exchequer from 1979 to 1983. We reminisced about some of the changes he introduced, including the liberalisation of credit. Until 1982 credit for most consumers meant hire purchase, essentially a loan from the store, and there were strict rules governing how much could be borrowed. His abolition of hire purchase controls in that year, together with other liberalising measures during his time in office, changed the credit climate irreversibly.

Today, of course, plastic cards are ubiquitous. There are 70m credit cards (11m of them Barclaycards), 67m debit cards (a later innovation) and just under 5m charge cards in use in Britain. That does not mean everybody has one - the average credit card user, for example, has more than two. Take-up of credit cards in Britain is 63% of the adult population, higher than in most European countries but lower than the 80% in America.

As one who regularly snorts with impatience when waiting in a queue behind somebody making a ridiculously small purchase with a credit card, I was surprised to discover it was only as recently as 2004 when plastic (credit, debit and charge cards) overtook cash as the main form of payment.

What has been the effect of easy access to credit cards? Many people worry that as a nation we are wallowing dangerously in a lake of debt and that it won’t take much - perhaps an interest rate hike or two - to push us under. As an aside, last week’s MPC (monetary policy committee) minutes did not suggest that is going to happen soon, though credit card interest rates, including Barclaycard’s, have been rising.

The Consumer Credit Counselling Service said last week that the number of people in “extreme debt” had doubled over the past year. It dealt with 280,000 clients last year, and found that the biggest problems were not among the young but the middle-aged, 40-59 year-olds. The Citizens Advice Bureau says it helps more than 1m people a year who are struggling with debt problems. Personal bankruptcies have been rising sharply, though partly because of changes in the law.

One of the most difficult things to get across is that you can have a situation where many people are struggling with debt, but it is not a macroeconomic problem. Mervyn King, the Bank governor, tried to square the circle recently by describing the number of people getting into difficulty over debt as “a potentially large social problem”. The question, perhaps, is how far such a problem has to go before doing some economic damage.

The Bank’s latest survey, carried out with NMG Research, was published last month. It showed that two-fifths of households were debt-free, 43% had mortgages, and 41% had unsecured debt (some, of course, have both). The vast majority of households have more assets than debt. About one in 10 households with unsecured debts found them to be a heavy burden; in other words some 4% of all households. The proportion has not changed much over the past decade.

The number struggling with their mortgages, about 7% of those with home loans, has risen over the past three years but is still lower than it was for most of the 1990s.

For those who are concerned about debt, credit cards offer the easiest access to it but it would be misleading to blame them for household indebtedness. Britons owe £1,191 billion, equivalent to more than 95% of the UK’s gross domestic product, but £999 billion of that is accounted for by mortgages. Of the remaining £192 billion of consumer credit, £56 billion - under 5% - is owed on credit cards.

This is as it should be. Given the rates of interest charged on credit cards, nobody should borrow on them for any length of time, as former Barclays' head Matt Barrett once famously pointed out. And, while mortgage lending is up by near nearly 11% on a year ago, the growth of consumer credit has slowed to 7%.

Credit cards, meanwhile, are undoubtedly of benefit to the economy. A report on the credit card industry by, an economic consultancy, found that its contribution to employment was 111,000, and to the exchequer more than £8 billion of taxes each year.

Credit cards save £5.5 billion a year over paper-based payments systems, and have saved consumers more than £1 billion annually in interest (the interest-free period between transaction and payment). Cards allow people to smooth payments.

“Even taking debt into account, credit cards have been of significant net benefit,” said Paul Guest, the report’s author. Perhaps the easiest way of thinking about this is to imagine life without credit cards. Internet businesses would struggle, as would many others. The effect of getting rid of credit cards would be to cut GDP by £22 billion over three years, mainly by reducing consumer spending.

Some would say that would be no bad thing. But spending is the economy’s lifeblood. Credit cards help keep it flowing.

PS Not everybody will know of Toshihiko Fukui but they should note the name. The Bank of Japan governor is caught up in a scandal over his investments in the Murakami Fund, whose founder Yoshiaki Murakami, was arrested this month for insider trading. Fukui’s defence is that he sold up in February, though he might have known then the authorities were preparing to move against Murakami. The governor has shed public tears and offered to take a pay cut.

Of rather more interest outside Japan is what Fukui (if he survives) and his colleagues might do to interest rates. Japan has had zero interest rates since 1999, apart from a short break during late 2000 and early 2001. The policy finally paid dividends with economic growth of nearly 3% last year and, more significantly, the recent end of the long period of deflation, or falling prices.

The zero interest rate policy, however, is set to end. Fukui said last week policy would be “proactive”, which some have interpreted as an end to zero interest rates as early as next month. Others are not so sure.

Grant Lewis, a Daiwa Securities economist, thinks the Bank of Japan will delay until the autumn, and the end of prime minister Junichiro Koizumi’s term in office. But he thinks when rates rise, they will eventually do so significantly, ending up at 3%. That really would be the end of the cheap money era.

* Some things are far more important than interest rates. The sudden death at 43 last week of David Walton, a member of the Bank of England’s monetary policy committee, was both shocking and incredibly sad. He leaves a wife and young family. I had known him for nearly 20 years as an excellent economist and a thoroughly decent man. I shall miss him a lot.

From The Sunday Times, June 25 2006


Hi David

This may be a really stupid question but when you say "That really would be the end of the cheap money era" do you mean for the whole world as well as the Japanese?


Johnny C

Posted by: JohnnyC at June 25, 2006 11:45 AM

Debt won't bring the house down, unless we get some interest rate hikes in the next five years, or tens years, or even longer.

Posted by: Werewolves at June 25, 2006 04:57 PM

Debt won't bring the house down, unless we get some interest rate hikes in the next five years, or tens years, or even longer.

Posted by: Werewolves at June 25, 2006 04:58 PM

In response to Johnny - I meant Japan, the last shoe to drop, the cheap money era is already over in the US, is on its way out in Europe and it is a long time since we had a 3.5% base rate in the UK.

In response to Werewolves, I've no doubt interest rates will rise (and fall) over the next 5-10 years. The serious sensitivity analyses suggest the household sector could take a lot of pain on rates, though not the small minority in real debt difficulty.

Posted by: David Smith at June 25, 2006 06:26 PM

Trouble is according to the leading lenders' current bad debt insurance, (Barclays Bank's bad debt provision has soared 20% to GBP706m in the first half of this year alone!), there are an awful lot more people in real debt difficulty than is given by the official "doorstop challenge" surveys upon which those debt sensitivity surveys are based.

As these institutions have scrambled to leverage maximum customer share from low rates resulting from currency carry trade in Japanese yen, so they have (aggregately) exposed themselves dangerously (I mean their customers of course) to interest rate rises.

I'm quite sure that when rates go up and bad debt provision grows by 20% again and personal bakruptcies go up by another 40% on the previous year as it did this year, many economists may say that the issue of debt took them by complete surprise!

In this way, I think of economics as dismal not only in Thomas Carlyle's reckoning, but as a discipline which sadly, completely lacks scientific rigour at all ("ceteris paribus" still seems a very hollow term). For example, ask a scientist about an experiment under certain conditions and they'll give a pretty accurate answer about the result. Ask an economist the same thing and you'll get an opinion, based on another opinion and a reliance on the audiences' collective short memory if they're wrong.

Not having a dig at you David (or at any other economist), just a general observation.

Posted by: Terry at July 1, 2006 12:59 AM

Dear David,
RE:Debt won't bring down our house of cards ?!

You might well be right on the above assumption, on its own it probably won't bring down the house of cards.

But consider this, all parents in brittain are problably house owners or aspiring ones. In the course of their parental night time story they may have come across "Pinochio", upon reading it there is an evil man promising the best of times to innocent childeren, who are then turned into donkeys to work in the salt mines....... I could not have found a clearer way to explain the current UK economic (Miracle)!!! I leave you and others to substitute the characters with those of Her Majesty government and opposition.

Best wishes,......
and don't drink the lemonade!!!
Arik Schickendantz

Posted by: Arik Schickendantz at July 6, 2006 11:27 AM

Hi David,
I am in agreement with Terry that surveys on debt are not scientific and in any event rely on respondants being truthful in their response.
The simple fact of the matter is that the banks have massively over extended credit to many people. It will only take sustained interest rate hikes and an economic downturn for the situation to reach melting point. Interestingly Barclaycard cash rates (a mainstream lender) on some of their cards are now as high as 37.9%. That is not sustainable for the sort of people who will carry high balances on their cards. My take is that they are profiteering now to pay for hard times ahead.
On a slightly different note it is absolutely crazy that banks allow credit cards to be used for gambling transactions. Quite simply apart from the poor economic sense it is immoral and the practise should be stopped by legislation if necessary. Again they take the greedy line and now treat gambling transactions as cash advances in order to eek more money out of those who already have problems. Check out

Posted by: Anthony Franklin at December 15, 2006 01:13 PM