When does the debt crisis become the DEBT CRISIS?

10 years after Financial Crash the governments, corporates, financials and households hold record debt. What strategies is each adopting to pay it down?

Debt, what debt?

A sign that someone is in financial trouble is when they stop opening their post. Letters from credit card companies, the mortgagor and others become too frequent, too demanding and their ink too red. The debtor closes their mind to the problem.

The world has stopped opening its post. Global indebtedness has reached perhaps 325% of global output or $217 trillion according to the Institute for International Finance. Yet governments, central banks and the financial sector appear quite sanguine or are they just pretending there isn't a problem?

Governments are the biggest offenders; their share of the total global debt has been soaring. Corporate debt is second in line followed by financial and household debt that has, by comparison to the first two, risen modestly.

Fretting about such a magnitude of debt is the broken record of the gold bugs talking their own book. But an illustration of the equanimity with which the world is facing up to its debt is that, surprisingly, gold has hardly budged in recent years. There is no rush into bullets, beans and bullion as they head for the hills and away from some impending disaster.

How the debt will be repaid

But let's put aside hysterical talk of a global crash and the actions that will be required to redeem the situation. If the bubble goes "pop", it is interesting to speculate (if that is the appropriate term) about how the debt will be repaid.

That is unless it is assumed that this level of indebtedness is sustainable. It wasn't in 2007 when indebtedness was less than half what it is today. Uncontrolled credit expansion then led to the global financial crisis when the world was "saved" by "extraordinary monetary measures" that were invented for the occasion.

It is ironical that these extraordinary monetary measures in the form of quantitative easing have been responsible for the acceleration of debt surpassing the starting point in 2008 when they were implemented.

Strategy, what strategy?

So how is the debt going to be repaid? Has government borrowing been applied to such social investment as education and improved health or physical investments like restoring battered infrastructure that will raise productivity levels and future prosperity? No, not really.

Have governments been cutting back to reduce current expenditure? No, not a lot. Are governments projecting that tax receipts will rise because of improved supply side conditions? That would be the triumph of hope over experience.

Central banks have been buying debt to "print money" to stimulate the world’s economies. They have been warehousing unheard of volumes of debt that it is likely they will hold to maturity in the expectation that the issuers will be in a position to repay the debt.

Corporates have been borrowing because interest rates are low. But have the borrowings led to greater capacity and productivity that will give the corporates greater profits and raise the capacity to pay down the debt. Or have corporates fallen for the error of buying things in the sale because they are cheap, not because they need them?

Assessing assets

Financials have been borrowing to invest into the assets that have risen as a result of QE. They are congratulating themselves on the gains in stock markets and property investments.

And households have been spending instead of saving. Saving levels are amongst the lowest in modern history. Households too have benefitted from artificially low interest rates. An illusory "wealth effect’ has made them feel better off than they are. It this "wealth effect" has led households to borrow more than they can afford if interest rates take off. Wages have been constrained. Perhaps there is the hope that when wages return to the long-term trend that debt will be paid off. Perhaps there is the expectation that increased productivity will be rewarded if that productivity can be found.

But what is more likely is that an unspecified "event" probably the collapse of a financial institution like the New York Stock Exchange crash in 1929 or the collapse of Credit Anstalt in the 1920’s and 1930s or the failure of Long-Term Capital Management (LTCM) in 1998 that was the canary in the mine that died before Lehmann Brothers collapsed in 2007 will be a trigger.

The Great Depression saw global GDP cut by 15%. If global GDP were to drop by that proportion today indebtedness to GDP would, by merely staying the same in nominal terms, soar as a proportion. Any belief or expectation that there would be an orderly retreat from the flood of credit that has been created would be dashed.

This comment sought to discuss the strategies that different, indebted, sectors of the economy could adopt to manage their debt downwards in a more orderly fashion than has been achieved in the past. Time will tell whether lessons have been learned.

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