The great hangover

US lifestyles: America’s standard of living could be the main casualty of the debt crisis. For a decade, the middle class made up for stagnant incomes by getting ever deeper into hock. Without housing wealth to tap, a bout of inflation is one of the few alternatives to a decade of austerity.

The right to a perpetually improving lifestyle is not in the US Constitution. But as far as many Americans are concerned, it may as well be. So when average family income failed to advance over the past 10 years, few took it lying down. With the median income of a working family sliding from $60,700 in 2000 to $55,800 in 2009, the favorite solution was to make up for the shortfall with large dollops of seemingly cheap credit. While much of this debt has been paid off since the financial crisis, or been erased through a flurry of defaults, household debt still stands at 123 per cent of annual disposable income. This is still historically high – even at the height of the go-go 1980s, American household debt only reached 85 per cent of disposable income.

Paying this down further will be no mean feat. At the current rate of savings – close to 6 per cent of disposable income – getting debt down to 100 percent of disposable income will take four years. And that won’t come close to restoring the $10.7 trillion of household net wealth lost since 2007.

Against this backdrop, it is hard to see how Americans can avoid tightening their belts over the coming decade. Wage growth is unlikely to be much more helpful than over the previous cycle. Intensifying international competition seems to have severed the customary link between improving productivity and rising wages and high unemployment is adding an extra headwind.

Nor will most Americans be able, or willing, to repeat the trick of borrowing to bridge the income gap. Homeowners’ equity has almost halved since 2005, reducing the collateral of households by about $6 trillion. Default is no quick fix either, since it cuts consumers off from access to new credit and still carries with it a degree of social stigma. This leaves inflation. With debtors vastly outnumbering savers in America, a burst of faster price rises may be the most politically palatable way of eroding the real value of debt. Of course, even this option would leave the middle class at the mercy of pay increases. Add it up and it's hard to see how many Americans can avoid a stagnant, or even lower, standard of living.