Global debt is increasing and it is putting an increased pressure on all other asset markets. According to the latest figures put out by the IMF total global debt now stands at an astonishing USD 307 trillion- up from USD 226 trillion at the start of 2020, and now represents 336% of global GDP.
What exactly does this mean and how is it going to impact markets? The total debt outstanding is measured as the aggregate sum of all borrowings across governments, corporates, and households worldwide. And all three can be both borrowers and lenders simultaneously and often are. Consequently, all our actions are governed in some way by the necessity to service those debts: households in the way they consume or work, corporates in the way that they borrow or invest, and governments in the way that they tax or spend. And with debt forming an ever-increasing percentage of our earnings or output- currently at just over 3 years and 4 months of earnings or production, it is reaching critical tipping points.
Fig. 1: Outstanding Global Debt
The chart above does not include the IMFs own data point which shows the upsurge in outstanding in the last one year.
The level of debt one can support is affected by two critical factors: the ability to generate earnings to satisfy the repayment terms, and the rate of interest that the debt carries.
We have seen rising yields on US government securities impacting markets globally- from sovereign nations with Dollar denominated debt that resets periodically, to corporates that face the same issues (see the case of Evergrande or even Country Garden Holdings to understand how rising rates can be the straw that breaks the camel’s back), whilst households and the housing market are being impacted by rising costs for servicing their mortgages. In the case of sovereign servicing of international debt, the IMF estimates that over 100 countries will be forced to curb spending on social programmes, health, and education- deeply affecting the economically disadvantaged even further. A World Bank study showed that countries with a 77% plus Debt to GDP ratio for extended periods experienced economic slowdowns. Half the G-20 nations, including the US, the EU as a whole (Germany is an exception), the UK are all well over that benchmark. Japan – at 262% (end 2022) is at a Ponzi scheme level of government debt.
The rising Dollar and rising US rates are forcing countries to raise domestic rates to preserve their perceived currency parity with the Dollar so as not to import inflation through rising trade deficits. Many Asian economies- like Indonesia and South Korea, are seen as likely to raise rates within the next 6 months to combat the runaway Dollar. It is also important for developing countries and smaller nations to maintain an interest differential with the Dollar in order to be able to attract sufficient investment flows to make up for any domestic savings gap. This is going to create problems of money velocity in the economy as companies find it more expensive to source funding and households face a steeper opportunity cost for discretionary consumer spending.
The booster fuel to administered rates being hiked to combat inflation is the Quantitative Tightening that some central banks are undertaking. It is necessary and a complementary move to making money more expensive by making it less plentiful. The Federal Reserve, Bank of England, The European Central Bank, Reserve Bank of India and so on, all embarked on a ‘flood the system’ policy in the wake of the Covid pandemic. Much of it went straight as an adrenaline shot to the equity markets, boosting property prices, and even lifting Gold and Bitcoin. Now, with economies back on track despite additional supply side hiccups caused by the Ukraine War, the Easing programme is now giving way to the Tightening one. But there are two ways to tighten- let the additional debt holdings mature or sell them off into the market. The first one risks letting inflation dig in for a little longer, the latter drives up yields and corporate spreads. It isn’t hard to guess that central banks have gone for the latter.
US Yields- the most important benchmark for global bond market pricing, crossed above 5% where the 2-year and 30-year now reside. The 5 and 10-year yields both hit this level but have since come lower. US mortgages are now hovering near 8%- a strong deterrent to new home purchases as repayment instalments become prohibitive. Over in the UK, the thinktank Resolution Foundation, has published a report which claims that the rate rises have caused UK household wealth to plunge by a quarter since the Covid-19 pandemic. This was due to the fall in housing prices and the decrease in value of their pension funds- mainly those invested in low-yielding Gilts which have taken mark-to-market hits.
The picture looks a little clouded in the near-term but it may have a sliver of hope for a reverse inter-generational transfer of wealth. Boomers have long been accused of benefitting from lower education costs and cheaper housing and high returns on their savings at the expense of the next generation. A fall in asset values- housing stock and equity, could work as a positive for the younger generation who can afford to ‘get in lower’ or even invest now at higher yields which will stand them in good stead in later years.
Apart from that, this growth in indebtedness is an overall negative- especially as yields rise and debts have to be rolled over at higher costs. Given the size of US deficits and their inability to agree on tax rises, they might be the next banana republic in terms of worthless debt. One lesser observed discussion is what the largest holder of US federal debt- China, will do in the wake of the ratcheting up of tensions between the US and them. Some observers have noticed an acceleration in the selling of US treasury Bonds by the Chinese in the last few months but no-one is saying that the Chinese are weaponizing their status as buyer-in-chief of US debt. Whatever the situation, if this does triggered while levels are near here, the debt house of cards will start falling around the world.