The process of reducing the rich world’s debt burden has barely begun

FOR Federal Reserve officials, marking down America’s economic outlook has become a depressing routine. A year ago they projected growth of about 4% this year and next. By last month they had chipped those numbers down to 2.8% this year and 3.5% next. “We don’t have a precise read on why this slower pace of growth is persisting,” said Ben Bernanke, the chairman. But he ventured that “balance-sheets and deleveraging issues” may be stronger headwinds than expected.

The same diagnosis may explain similar disappointments in other highly indebted rich countries. In late 2009 the Bank of England reckoned Britain would be growing by 4% this year. It now thinks it will grow by closer to 2%; the private-sector consensus is a mere 1.5%. The Bank of Spain has avoided similar climbdowns by starting out pessimistic and remaining so.

In a study early last year, the McKinsey Global Institute, the consultancy’s research arm, noted that combined public and private debt burdens had reached historic highs in many rich countries. Based on previous episodes of debt reduction, it reckoned that once deleveraging began, countries would on average spend the next six to seven years whittling those debt ratios back by around 25%.

McKinsey has updated some of those numbers and has found that although debt for the most part has stopped rising as a share of GDP, in only one big economy, America, has it visibly fallen. Private-debt burdens have begun to drop but across the rich world that has been offset by an increase in public burdens (see charts). Deleveraging is “just starting”, says Charles Roxburgh of McKinsey.

McKinsey’s original prognosis was grim: after a crisis, countries historically saw their economies contract in the first year or two of deleveraging. No big economy has yet fallen back into recession after exiting its post-crisis downturn (although that risk remains given the low level of growth and how far debt reduction has to go). But the deleveraging process helps explain why some recoveries have been vigorous and others tepid.

Germany and Canada, for example, entered the crisis with relatively low levels of public and private debt. In Canada household debt has actually risen as the country’s housing market has inflated. Germany has grown faster than expected, while Canada’s growth, at around 3%, has been on target.

Italy, France and Japan entered the recession with low household debt but high levels of government borrowing. France has implemented a fiscal consolidation plan; Italy’s cabinet approved one on June 30th. French growth is picking up but Italy’s continues to lag behind and Italian bond yields have risen lately as worries about peripheral European solvency spread. The earthquake and tsunami in March have disrupted both Japan’s recovery and its hopes of reducing its enormous debt burden.

Spain, Britain and America have the worst of both worlds. All three started with dangerously stretched household balance-sheets. Now, because of the collapse in private economic activity and the use of stimulus measures, the public books are in similar straits.

Even their experiences, however, differ in important ways. American households have already chipped their debts down to 112% of annual disposable income, according to Haver Analytics, from a peak of 127% in 2007. Britain’s decline has been less dramatic and Spain’s debt-to-income ratio has hardly fallen at all.

Mr Roxburgh thinks the differing legal structure of mortgage markets may explain some of the difference. In many American states, in contrast to Britain and Spain, a lender has no recourse to a defaulting homeowner’s income or other assets. The borrower thus has an incentive to default on a mortgage worth more than his home. Write-offs are running at around 2% of banks’ secured loans in America but close to zero in the euro zone and Britain.

In Spain and Britain house prices have also fallen less steeply than in America and borrowers have been cushioned by ultra-low interest rates, reducing their incentive to pay down or walk away from debt. Higher mortgage payments will add to the squeeze on Spanish households, however: the European Central Bank was expected to raise short-term interest rates for the second time this year on July 7th after The Economist went to press. The Spanish government is trying to lessen the pressure, announcing on July 1st that more of a borrower’s income would be shielded from seizure, and more of a mortgage could be cancelled once a property is auctioned.

Britons have raised their savings rates more than Americans or Spaniards, despite a smaller increase in unemployment and comparable trends in income. A 2010 survey for the Bank of England suggested the government’s drastic deficit-reduction plan may be a reason: 18% of respondents expected to save more in response to higher taxes and reduced public services, and just 3% expected to spend more.

This cannot fully explain Britain’s lacklustre recovery—higher fuel prices and disappointing export growth are also to blame. But it is still a cautionary tale for America. Both Britain and Spain “have adopted sobering deficit-reduction plans that have severely hit households’ expectations of real disposable income whereas the US has not,” says Simon Hayes of Barclays Capital. That may change soon: the Obama administration and Congress are currently negotiating a deficit-reduction package that could amount to $4 trillion or 2% of GDP over ten years. In June the IMF urged America to slash its structural deficit by a cumulative 7.5% of GDP by 2016, enough to trim 0.5-0.75 percentage points off average growth over the period. If that advice is followed, Mr Bernanke should brace for more downward revisions.