Here's The #1 Threat To The Economy At Least Until 2012

deleveraging debt

Photo: Deutsche Bank

Deleveraging.You’ve heard this term a lot because it’s a huge deal, and the fact that households are still deeply in debt (though not as bad as they were two years ago) is a major drag on consumer spending.

In a new report from Deutsche Bank’s Peter Hooper and Torsten Slok, this issue is examined more deeply — how much deleveraging has been done, why it’s ongoing, and how much more there is.

Their conclusion — yes, we’ve already made substantial progress, but we’ll be doing a lot more, through at least 2012.

First of all, household debt has come solidly off its peak, though it remains very elevated.

Defaulting on debt has been a major driver of this deleveraging

But there's still plenty more to go

We're now back to a 30-year average in terms of debt service ratios

But we still have more to go on this front. Expect an overshoot.

Household leverage isn't just about income, it's about assets, too, which have come way down.

Obviously the decline in housing has been a balance sheet killer, although it's not the only factor

Here's a look at how badly household assets have been dragged down by houses

In general, though, assets should grow roughly in line with income

Right now, the relationship between household net worth and income is at its historical range

Meanwhile, expect the savings rate to grow (DPI = Disposable Personal Income)

In conclusion

Here's how Deutsche Bank sums it up:

The implications of this projection for the growth of consumer spending and the overall economy are downbeat in the near term, but more positive as we look beyond 2011. This analysis suggests that households have more balance sheet adjusting to do as they continue to react to the sharp decline in their wealth that occurred during the recent economic and financial crisis. This adjustment, if it continues to occur, will be a significant drag on growth through 2011; potentially enough to hold the economic expansion to or even below trend. However, the effects of the more recent firming of the stock market and the ongoing rundown in the household debt should begin to bolster wealth enough to put the saving rate on a mildly downward trajectory again in 2012, enough to allow consumer spending to become a modest engine of growth again. With pent-up demand for consumer durables likely to be building in the interim, the economic recovery could very well turn up more briskly in 2012 and beyond.

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