The world’s forgotten how to fly, without $243 trillion of debt.
“They had forgotten how to fly”, Helen Norton, reproduced with permission.
Key central bankers in the US, EU and UK are no longer seriously pursuing interest rate and balance sheet normalisation strategies.
Japan never started, China is injecting more accommodation into its economy and the EU is standing by to do so if required.
Here in Australia, a rate cut is just as likely as rates on hold for longer.
Why?
Well, for one thing, global growth has slowed. But just as importantly the global interest bill on current debt levels would become unaffordable if interest rates in the major economies were to rise anywhere near to pre-GFC levels. For each 1% in interest charge, the global bill would increase by US$2.43 trillion, or a little over 3.2% of global GDP.
Also, at a point in time (probably not so far from where we are now) the interest bill would cause GDP growth to stall and move into reverse gear.
Government and householder attempts to deleverage decades of debt formation leading up to the Lehman collapse, have failed.
Interest rates are no longer increasing in the US. Key central banks have stopped tightening. Government deficits are growing. In Europe, the central bank has been calling for additional fiscal instruments to be put in place to deal with another financial crisis, should one occur.
Essentially, the world is addicted to debt. It’s a cheap global Rohypnol, and its pushers are the central bankers that continue to feed willing and anxious consumers.
So, how much debt are we talking about?
Excluding all forms of unregulated/unreported/shadow debt and certain derivative products, about US$243 trillion, or just under one quarter of a quadrillion!
Assuming about US$76 trillion in global GDP, this tells us that the world is about 318% leveraged before taking shadowy/derivative debt onto account.
Attribution: Institute of International Finance (IIF), April 2, 2019
Whilst total debt to GDP has slowed from its peak in 2018, it has not slowed since the collapse of Lehman in 2008. In fact, it has expanded by around US$70 trillion (or an eye popping 40%) and debt to GDP has increased by about 38 absolute percentage points.
Source: Bloomberg.
Where’s the productivity?
What’s really worth noting is that incremental debt plus all other forms of investment has only produced an additional US$14 trillion in GDP, i.e., representing 10 year growth of 20% (or about 2% compounding annual growth).
This means that only 20c in each dollar (or US$14 trillion) of the US$70 trillion in incremental debt has so far been represented by incremental global goods and services. Let me use a very loose term ‘20c in the debt dollar of productivity gains’.
Whilst this sounds like a highly unproductive use of debt (either that, or it’s benefits have simply been allocated to investors and secondary markets), remember that for 10 years it has almost had a negative cost, given zero and negative interest rates throughout most of that period.
As I’ve previously written, the great lochs and lakes of free and easy money remain, and it does not look like current central bankers have the bottle to drain them any time soon.
But who or what has borrowed the US$70 trillion since Lehman?
80% has been borrowed by Governments and non-bank Corporations.
Extrapolations from Bloomberg data suggest that in the 10 or so years since the GFC, Governments have stacked on an additional US$30 trillion in debt. Think about deficits, QE and deficit funded tax cuts that the world will never be able to repay.
Households have also had a US$10 trillion field day, and that’s been quite evident in the increasing household debt to disposable income metrics from around the world.
But, it would seem that banks and other financial institutions have been reigned in by toughening prudential standards. Still, I would say that if Donald Trump is successful in revoking the Volcker Rule and/or loosening up or shredding Dodd-Frank, this will change.
Forgotten how to fly?
The world has forgotten how to live within its means, and regrettably the world can no longer fly without a massive debt fueled balloon to hold it up.
I’ve often said that the biggest problem with the GFC was that we made it through. That is to say that the only reason we made it through was due to taxpayer funded bail-outs of ‘too big to fail’ institutions and companies in the US, and global QE that set the stage for free and easy money.
Had this not occurred, various politicians would have been guillotined, however the printing presses may not have brought us to where we are today. We also have a highly geared Chinese economy with a ‘visible hand’ Communist Government standing ready to hand more and more financial accommodation to the people.
What is crucial to understand about all of is that the events following Lehman will continue to influence monetary policy, currencies and commodity prices for many years and in turn, the markets for equity, debt, M&A and general investment.
Proponents of Modern Monetary Theory (MMT) don’t seem to care. Just as easy as it has been for certain Governments to promote that climate change is not at a tipping point, I expect there will be many MMT proponents and others telling us to ignore the size of the global debt lake and swelling Government deficits.
In the meantime, central bankers will shift from dove to hawk and back again, and our massive debt wall and lakes of free and easy money will be with us for a very long time.
Regards, Mike.
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