When excessive debt leads to financial crises, the necessary, but painful step is to deleverage. That means allowing debt to be liquidated, allowing government, businesses and household debts and spending to shrink. According to McKinsey, the typical deleveraging of a country lasts six to seven years, results in the government’s debt-to-GDP ratio falling by 25%. During the period of deleveraging, GDP usually falls for several years.
But at least in the U.S., the Great Deleveraging never really happened. GDP contracted in 2008, was barely negative in 2009, and has been positive since then. Debts have not been reduced. According to tradingeconomics.com, the ratio of U.S. government total debt-to-GDP was about 65% in 2007, surging to 76%, 87% and 95.2% in the years of 2008-2010, and currently resides around 103%. This ratio is the highest it has been since World War II.
Unfortunately, a similar story has played out across much of the globe where governments have been unwilling to let markets reset. Since 2007 the Eurozone’s government debt-to-GDP ratio has increased from about 66% to about 92% (in 2014). China’s government debt ratio has grown faster than its economy, increasing from about 35% to about 41%. (The more pressing problem in China is the explosion of non-government debt and lending, mostly real estate and “shadow banking”, with China’s total debt growing from $7 trillion in 2007 to about $30 trillion today.) Japan’s debt-to-GDP ratio has increased from 167% billion in 2007 to $230 billion and Greece’s from 105% to 177%.
The growth in global debt is not just with the government, although they have been the biggest offenders in recent years. If you look at the chart below, we see that each debt-carrying sector of the economy – government, financial, corporate and household – increased total debts from 2000-2007 and then again from 2007-2014.
Household 8.5% 2.8%
Corporate 5.7% 5.9%
Government 5.8% 9.3%
Financial 9.4% 2.9%
In comparing the pre-crisis years (2000-2007) to post-crisis we see that households have been “deleveraging” somewhat. Still increasing their debt, but at less than a third of the rate they were before the crisis. The same is true for financial institutions. While it would have been better if there had been actual liquidation and deleveraging among financial institutions, at least financial company debt has not been growing by the levels of the early 2000s. (During the financial crisis, if you recall, the steps that would be taken to deleverage financial institutions once the crisis was over was talked about constantly by government officials. That deleveraging never happened.)
Growth in corporate debt has continued at a high rate, which would be expected with such rock-bottom interest rates. When borrowing rates are so low there is a fiduciary duty to leverage the company by borrowing, and then invest in corporate projects, retire stock, pay dividends, issue stock options or engage in other financial management for the benefit of shareholders.
And then of course, the big one, government spending. Governments have been the white knights riding in to save the day from companies, individuals and financial institutions restraining themselves and correcting their overspending ways. About every person on the planet knew that the 2007-9 financial crisis was too much debt, so what was the solution by governments? Of course, more debt. Global governments, which had already averaged 5.8% yearly growth in their debts in the seven years before the crisis hit, have upped their annual additions to debt by an average of 9.3% per year, since 2007. According to the Economist’s Global Debt Clock, the world is currently adding to public (government) debt at the rate of about $1,000,000 every 12 seconds.
All told, global governments have added more than $25 trillion since 2007, to about $58 trillion by the end of 2014. According to the World Bank, the current world GDP (Gross Domestic Product) is about $77 trillion, up from about $60 trillion in 2007, suggesting an increase in GDP of about $17 trillion since 2007, much less than the increase in government debt alone. While government debt outstanding “only” makes up a little more than a fourth of total debt, it is perhaps the most influential, because it is the least backed by real assets. Corporations, households and even financial institutions have at least some real assets underlying their debts. Governments’ primary “asset” is their ability to tax and borrow.
There has been increasing discussion over the years as to how much government debt is “too much”. Whether there is a “tipping point” of government debt-to-GDP at which countries cannot recover. Figures of 80%-100% are often cited as such dangerously high debt-to-GDP ratios. A report from the IMF in 2014 (“Debt and Growth: Is There a Magic Threshold?”) found that there doesn’t appear to be a line of government leverage in which it becomes impossible for counties to survive, but there are consequences to high debt levels.
Even if we assume GDP numbers as fact, (which I don’t because they are easily fudged by governments who want their outstanding debt to look more acceptable to borrowers) using published debt-to-GDP ratios shows that countries are becoming more leveraged, not less.
McKinsey looked at the change in debt-to-GDP ratios of more than 40 emerging and developed countries during the period of 2007 to 2014 and found that just five of them – Argentina, Egypt, Saudi Arabia, Israel and Romania – reduced their debt-to-GDP ratios. Not one “developed” economy deleveraged, but in fact all borrowed more than ever even factoring in the growth of their economy. That includes countries such as the U.S., the U.K, Spain, Greece, Portugal, Ireland, and Japan, countries that already had debt issues coming into 2007.
In their report on debt-to-GDP ratios and future economic growth, the IMF found that a country’s debt-to-GDP level was an important factor in growth rates – those countries with the highest debt-to-GDP ratios tended to have the lowest amounts of economic growth. However, they found that the more important variable was the direction of debt-to-GDP levels.
For example, a country with a debt-to-GDP ratio of more than 90% but with a falling leverage ratio, on average, has positive economic growth. In contrast, a country with a debt-to-GDP over 90% with a rising debt ratio, on average, will have negative GDP the following year, and weaker economic growth than those countries with improving debt ratios over the following 15 years. In addition, they found that highly-indebted countries with rising debt levels tend to have more variability in economic growth in the years thereafter. In other words, more booms and busts, but with lower overall growth.
And of course, weaker economic growth makes it more difficult to service the debt so more borrowing is necessary and the cycle continues. Without real discipline, government officials typically take the path of least resistance, borrowing, spending and money-printing until the next crisis arrives.
Based on the growth rate of global debt during the period of 2007-14, about 5.3%, in about 31 years global debt should surpass $1 quadrillion. A million billion dollars. Will the global economy have grown enough to support that level of debt or will it be undone by its own creation?