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Friday, 7 July 2017

Global Debt Monitor

On 27 June 2017, the Institute of International Finance (IIF) published its Global Debt Monitor. IIF: “Growth in global debt has slowed over the past several years, particularly in mature economies. However, with EM economies borrowing more heavily, global debt has set a new record high of USD217 trillion (over 327% of GDP) in early 2017.”

These numbers are so huge that they become meaningless to most people. I'm not sure if they are alarming in and of itself. It takes slightly more than 3 years to “repay” this debt through Gross Domestic Product (GDP). Three years is not a lot if such debt is collateralized (e.g., mortgages). Without collateral, 3 years is huge.

Due to Quantitative Easing (QE) programs in Europe and USA, interest levels – and thus borrowing costs – are artificially low. QE programs work like this: Central Banks buy financial assets (e.g., bonds) with new money. This causes asset price inflation. If asset prices go up than market interest goes down as the nominal interest remains the same. See my 2016 blog.

When QE programs stop then market interest rates are no longer forced to go down. A reverse trend will start: financial asset prices will go down (lack of demand) and market interest rates will go up (because nominal interest remains the same). Upward market interest rates will ultimately hurt everyone who borrows money.

QE programs were introduced to “speed up” the economy. The idea was/is that low interest levels - or “cheap money” - will boost capital expenditure and investments. I doubt that as interest rates are a minor concern in any commercial business case. The financial services industry may have profited most which may also explain sluggish economic growth.

The real danger of “cheap money” is in a national debt crisis. Cheap money is like a drug addiction to governments. Future repayment is the responsibility of future politicians. Unlike consumers and (non state) corporations, governments usually expect to be bailed out, like Greece (EU) and Puerto Rico (USA). Also see my 2015 blog.

Higher borrowing costs would test highly indebted countries, like China and USA. This also explains recent warnings on an imminent Chinese - and global - recession. The USA has the luxury that the USD is still a global reserve currency. Balancing budgets, debt ceilings, and protecting capital outflows are less important to them. Rating agencies are worried about China and downgraded China's credit rating last May 2017 (eg, Moody's).

The Netherlands faces an ECB TRIM investigation due to its immense level of consumer mortgage debt. The Netherlands is a small country with many people, low supply of new houses, a huge demand in certain areas, and very low interest levels due to ECB's QE. Hence, house prices are sky high again but Dutch consumer mortgage defaults have always been very low.

I'm more worried about consumer, corporate, and government debt in countries without an independent banking system that is also at arm’s length from its government. The real debt risks are in countries where banking and politics are intertwined.