by Alasdair Macleod, GoldMoney:
It has been recently estimated that global debts stand at $284 trillion equivalent, representing 355% of global GDP. Estimates such as these must be treated with caution, and they probably underestimate financial sector debt. Furthermore, no allowance in these figures is made for OTC derivatives, which according to the Bank for International Settlements have a gross value of $15.48 quadrillion(!), netting out at $609 trillion.
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This article comments on the different debt sectors: government, finance, non-financial corporate and consumer debt. It finds the dangers of excessive corporate debt have had the least attention, and that systemic risk in commercial banks is grossly underestimated.
The rapid growth of emerging market corporate debt is a recipe for a repeat of the Asian crisis in the late-1990s.
Ultimately, the whole debt burden will fall on government shoulders in their threefold attempt to protect the banks, stop a recession and to continue puffing up a wealth effect by inflating increasing amounts of currency into financial markets.
The trigger to end the debt crisis is almost certainly rising bond yields.
Times of monetary expansion generate a shift in wealth from bank depositors to borrowers. Given that this year is the fortieth anniversary of the Nixon shock, when the world’s currencies finally came out as fiat, it is hardly surprising that each successive crisis led to the easier path of increasing debt instead of letting failing businesses and banks go to the wall. Kicking the can down the road has been the way to deal with every economic or financial blip. After all, it is argued, inflation reduces debt obligations over time.
Maybe, but it increases the net present value of future obligations to the ultimate destruction of welfare-driven states. This is why, if for no other reason, kicking cans down the road just ends up at some point with a pile of cans that can no longer be kicked. But politicians aware of mounting obligations and still doing the can-kicking believe that will be their successors’ problem, and you never know, something might turn up. After all, optimists argue, we survived higher levels of debt following the Second World War.
While most people are aware there was a financial crisis in 2008, they will surely fail to link it with the next one. For many reasons, they could be right. The Lehman crisis was driven by an excess of residential property speculation, liar loans and their securitisation. The next one is likely to be a bond, stock and currency crisis triggered by rising bond yields undermining the debt pile and weakening the dollar. It is only philosophising observers who notice that these crises happen regularly and have done so for a long time, approximately once every decade. The common link is debt, flowing and ebbing in periodic expansions followed by sudden contractions of bank credit.
It even occurred under a proper gold standard. Other than differences between successive crises the basic factors were the same, alternating between bankers’ caution evolving gradually towards carelessness, greed and then panic. But this last cycle, starting from the aftermath of the Lehman failure, has been totally different. State intervention in the form of previously unheard-of interest rate suppression has continued throughout the credit cycle. It is unsurprising that the can-kicking in the form of debt creation never paused and has accelerated with renewed vigour. Estimated to have been $175 trillion when Lehman failed, today the global debt bubble has increased to $284 trillion, according to a Bloomberg report, citing figures prepared by the Institute of International Finance. And with global GDP estimated at about $80 trillion a ball-park figure for debt to GDP of 355% is a workable assumption. Put another way, $3.55 dollars of debt are required for every dollar of GDP output.
It has always been reasonable in capitalistic markets for an entrepreneur to borrow working capital to cover the period between the initiation of a project and eventual sales of the final product, but in doing so he calculates carefully with a view to paying back his creditors out of profits. He continues to evolve his product to respond to competition and his reassessments of consumer trends. Research and development are funded by the business out of profits. Then came the financiers, who saw that a clear profit margin of, say 10%, could be turned into 20%, or even 30% by borrowing, not to finance anything but just to give leverage to profits, much of which they extract in dividends. They called it private equity, a misnomer for a process which at its base was and still is a means to gain advantage from the wealth transfer from bank depositors.
Financing for financing’s sake has taken over from honest capitalism, which is to compete to provide consumers with what they desire and need. It is no less than a corruption fully facilitated by fiat currencies issued by central banks in increasing quantities and at heavily suppressed interest rates. Micawber’s aphorism about debt being misery has been superseded by a leverage-based mantra that debt is good.
This loss of original purpose has been a bad thing, because consumption is never static, with consumers demanding progress. An entrepreneur delivers it by being flexible in his plans using debt as a temporary financing bridge. But when he is already loaded up with unproductive debt his commercial flexibility is compromised, and a needless proportion of enterprises end up as eviscerated zombie businesses. The smarter PE boys will have moved on and created similar problems elsewhere.
Then there is the legacy debt of major corporations who have become dependent on crony capitalism — the persuasion of politicians for preferential and monopolistic advantages. The replacement by lobbying of focusing on customer satisfaction has gradually driven them into a zombie state as well. Nearly half of the world’s debt is corporate, and if that’s not bad enough governments have also encouraged consumers to borrow to spend and ditch their savings.
How much debt is there?
Broadly, there are four debt categories: government, financial, non-financial corporate and consumer. Table 1 shows an approximation of global debt distribution.
Within these debt categories, there is significant variance. In government debt relative to their GDPs we see Greece at over 200% and Italy at 170%. These simple ratios do not take account of the fact that tax revenues, upon which a state’s financial credibility is based, are raised by governments entirely from their private sectors.
Taking a global average of general government spending at 40% of GDP, government sector debt is 172% of its tax base. A government debt to private sector GDP for Italy stands at 314%, Greece at 324% and France works out at 264%. In fact, the socialising EU nations’ government spending, being an average of almost 50% of their economies, means that their indebtedness relative to their tax bases can be doubled from the comparison with total GDP to give a more relevant assessment of their financial sustainability.