Earlier this year, the Institute of International Finance warned that global debt growth has reached an “eye-watering” pace over the past decade and hit an all-time high of $215 trillion last year.
The IIF said total debt levels, including household, government and corporate debt, climbed by more than $70 trillion over the last ten years to a record high of $215 trillion in 2016 – or the equivalent of 325%of global gross domestic product.
Most of the debt growth, the report warned, was driven by a “spectacular rise” in emerging markets, where total debt stood at $55 trillion at the end of 2016.
Ten years on from the great financial crisis, and it looks as if the world has not learned anything from this life-changing event. The global economy is finally starting to show signs of life after nearly a decade of sluggish performance but despite this backdrop, debt growth keeps rising.
The IMF estimates that the world economy will expand 3.6% in 2017, up from 3.2% recorded last year, and it is likely to grow 3.7% in 2018 — the fastest rate of growth this year, and back to the 30-year average.
Even though growth is picking up, credit rating agency Moody’s argues that this growth will not make it any easier for policymakers to raise interest rates.
In a research report published at the end of last week, Moody’s analysts point out that the “downshifting of US real GDP’s 10-year average annual growth rate has coincided with a climb by the ratio of nonfinancial-sector debt to GDP.” In other words, slowing economic growth has resulted in more leverage:
“When the average ratio of nonfinancial-sector debt to GDP rose from the 135% of 1960-1984 to the 175% of 1985-2001, the average annualized rate of real GDP growth slowed from 3.6% to 3.3%, respectively. In conjunction with the 229% average ratio of debt to GDP since 2001, real GDP growth has slowed to 1.9% annualized, on average.”
However, what’s interesting is that over the long term, benchmark Treasury Bond yields have tended to move in the direction ” taken by the underlying rate of growth for the US’s total nonfinancial-sector debt.” Specifically, the report notes that the annualized growth rate of nonfinancial-sector debt peaked at the scintillating 12.4% of the span-ended Q4-1986. Not long after, the 10-year yield peaked at 10.68%. Then during the second quarter of 2017, leverage debt growth hit 4.1%, joined ” by an easing of the benchmark Treasury yield’s moving 10-year average to the 2.64% of the span ended September 2017.”
Considering the above trends, Moody’s analysts speculate that unless credit creation increases markedly from current levels, the 10-year yields moving average should be no greater than 2.5% by the end of 2018. If credit growth fails to materialize, the case for another interest rate rise becomes weaker. High levels of leverage are holding back economic growth. – Rupert Hargreaves
There’s a scary little statistic buried beneath the US economy’s apparent stability: Consumer debt levels are now well above those seen before the Great Recession.
As of June, US households were more than half a trillion dollars deeper in debt than they were a year earlier, according to the latest figures from the Federal Reserve. Total household debt now totals $12.84 trillion – also, incidentally, around two-thirds of gross domestic product (GDP).
The proportion of overall debt that was delinquent in the second quarter was steady at 4.8%, but the New York Fed warned over transitions of credit card balances into delinquency, which “ticked up notably.”
Here’s the thing: Unlike government debt, which can be rolled over continuously, consumer loans actually need to be paid back. And despite low official interest rates from the Federal Reserve, those often do not trickle down to many financial products like credit cards and small business loans.
Michael Lebowitz, co-founder of market analysis firm 720 Global, says the US economy is already dangerously close to the edge.
“Most consumers, especially those in the bottom 80%, are tapped out,” he told Business Insider. “They have borrowed about as much as they can. Servicing this debt will act like a wet towel on economic growth for years to come. Until wages can grow faster than our true costs of inflation, this problem will only worsen.”
The International Monetary Fund devotes two chapters of its latest Global Financial Stability Report to the issue of household debt growth. It finds that, rather intuitively, high debt levels tend to make economic downturns deeper and more prolonged.
“Increases in household debt consistently [signal] higher risks when initial debt levels are already high,” the IMF says.
Nonetheless, the results indicate that the threshold levels for household debt increases being associated with negative macro outcomes start relatively low, at about 30% of GDP.
Clearly, America’s already well past that point. As households become more indebted, the Fund says, future GDP growth and consumption decline and unemployment rises relative to their average values.
“Changes in household debt have a positive contemporaneous relationship to real GDP growth and a negative association with future real GDP growth,” the report says.
Specifically, the Fund says a 5% increase in household debt to GDP over a three-year period leads to a 1.25% fall in real GDP growth three years into the future.
The following chart helps visualize the process by which this takes place:
“Housing busts and recessions preceded by larger run-ups in household debt tend to be more severe and protracted,” the IMF said.
Is there a solution? If things reach a tipping point, yes, says the IMF – there’s always debt forgiveness. Even creditors stand to benefit.
“We find that government policies can help prevent prolonged contractions in economic activity by addressing the problem of excessive household debt,” the report said.
The Fund cites “bold household debt restructuring programs such as those implemented in the United States in the 1930s and in Iceland today” as historical precedents.
“Such policies can, therefore, help avert self-reinforcing cycles of household defaults, further house price declines, and additional contractions in output.”
It’s no coincidence that household debt growth soared across many countries right before the last global slump. The figures are rather startling: In the five years to 2007, the ratio of household debt to income rose by an average of 39 percentage points, to 138%, in advanced economies. In Denmark, Iceland, Ireland, the Netherlands, and Norway, debt peaked at more than 200% of household income, the Fund said.
In other words: We’ve seen this movie before. – Pedro Nicolaci da Costa
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