Article / 09 February 2015 at 22:50 GMT

Debt explosion a heavy weight for economies

Business writer and editor
Australia
  • About 17 countries have lowered interest rate levels since January 1
  • Banks appear to have deleveraged more efficiently than other sectors
  • Despite the high levels, investors remain optimistic about repaying debt

By Adam Courtenay

The latest report on global debt levels from the McKinsey Global Institute is very worrying. Global debt levels continue to rise in the midst of record low interest rates. Based on the most recent numbers, the world is taking on the equivalent of the market capitalisation of a S&P 500 company every two-and-a-half years. The world is burdened with more debt now than before the global financial crisis of 2007, with China’s debt relative to its economic size now exceeding US levels, according to the management consultancy.

In eight years, global debt has risen $57 trillion, which gives the world a total IOU of $199 trillion. Debt levels are always a concern, but they are hardly surprising given the state of the world as we know it. If every central bank is lowering rates – at last count there have been 17 countries that have lowered interest rate levels since January 1 – then perhaps it’s hardly surprising that credit growth and the resultant debt that accumulates from it is rising exponentially.

Greece is the most obvious example, but the debt contagion, says McKinsey, has reached countries which were almost immune to it during the GFC. These include the Netherlands, China, South Korea, Canada, Sweden, Australia, Malaysia and Thailand.

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Debt is growing faster in countries such as Thailand, which has previously never
had a debt problem. Photo: iStock

What’s interesting, as the graph below shows, is that financial debt is low – the world’s banks, instigators of the previous debt splurge – have been deleveraging at a more efficient rate than any other sector. That's not to say their debt isn't still growing. This also applies to the countries where household debt had became unmanageable. The US and Ireland, for example, have very low household debt to earnings ratios compared to 2007.

The big problem appears to be the debt levels being manifested in the developing economies, even if it’s not only them – there are higher government debt levels in advanced economies as well. As one of the report’s authors, Richard Dobbs, puts it, the debt problem is a little like a balloon. “If you squeeze debt in one place, it pops up somewhere else in the system,” he says.

Looking at the graph below, one commentator noted that a trajectory of overall growth of debt has slowed significantly from a 7.3% annual growth rate in 2000-07 to a 5.3% rate in the past seven years, which equates to a 40% lower trajectory growth rate. “Those seven-year brackets are much too wide anyway. They should be in three-year brackets, and then we could see what the trajectory is lately. I bet it’s dropped considerably from 2011-14 from what it was in 2008-11, as budget deficits spiralled to massive heights only to drop off enormously as a percentage of GDP.”

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 Source: McKinsey

What does this all means for traders? Some are saying that if China is so indebted now, then we can forget any thought of recovering commodity prices. China – the market upon which the world’s mining industry is so dependent – has seen debt quadruple since 2007. It now represents 282% of GDP. Japan has a debt-to-GDP ratio of 400%.

China’s property sector, its so-called “shadow” banking system and consumer spending splurge are behind its debt blow-out. Eight years ago, China could put on debt and feel none of the consequences. Now it has to somehow weaken credit growth to rein in deficits. Reducing debt will reduce growth and hit imports. No wonder we’re seeing the revival in China of local companies mining a number of different commodities. China’s going DIY. It’s less open to global trade.

Gold, too, will have its day, say some analysing the McKinsey numbers. Investors should seek out investments that are not correlated with public and private debt, the most obvious of which is gold. If money is forced to vacate debt instruments and move to assets that are unrelated or negatively correlated to debt, they’ll be looking at cash assets – and precious metals.
 
The real worry here is that with debt growing at a faster rate than global GDP, there will be a number of black swan events and one big default will bring on a series of others as in 2007-08. It could be that because record low interest rates are widespread, investors remain optimistic in their ability to repay debt – or they are confident they can sell it on.

There are arguments which point to not having to be too worried about this. The Economist published an article about US household deleveraging relative to earnings that said it had been reduced from 135% in 2007 to 109% in 2012 and it has been steadily declining since. 

Others simply say that with interest payments so low, the debt can be repaid.  Either way, debt is on the rise. You can analyse the market any way you like, but the numbers don’t lie.

– Edited by Gayle Bryant

Adam Courtenay is a business writer and editor on TradingFloor.com, the home of social trading.


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