Debt is not necessarily a bad thing, when it is kept in check. In theory, debt is taken on to acquire necessary assets and promote future growth that allows the debt to be repaid. Unfortunately, years of rising debt and slow growth have thrown this out of balance and created a “credit bubble” that threatens the world economy.
A new report by the McKinsey Global Institute (MGI) points out that global debt has increased by $57 trillion since the Great Recession. The study analyzed the changes in debt over 47 countries (22 advanced economies and 25 developing ones) and discovered that the debt-to-GDP ratio is growing rapidly and disproportionately over the advanced economies, leading to the concern that much of the economic recovery is fueled by debt.
MGI focuses on debt from governments, non-financial corporations and household – defining the “real economy” as excluding financial corporations. Using this definition, all 22 advanced economies studied had increasing debt-to-GDP ratios, some at appalling rates. Ireland’s rose by a record 172%. Japan’s debt-to-GDP ratio is 517% while the U.S. comes in at 269%. Twenty of the 22 countries had debt-to-GDP ratios over 200%, and overall global debt was 286% of GDP. Only four countries decreased their debt – Argentina, Romania, Egypt, and Saudi Arabia, hardly bastions of stability.
MGI notes three areas of major concern:
- Government Debt – $25 trillion of the recent $57 trillion increase is government debt. This debt is likely to rise further given the collective economic stimulus and bailout programs, combined with weak and near deflationary economies in the Eurozone and Japan. The amount of economic growth compared to the debt increase is paltry at best. Some economists have argued that the stimulus packages are not large enough, but could the corresponding debt of greater stimulus bring the world economy to the breaking point?
- Household Debt – While the situation has eased somewhat in the U.S., the U.K., Ireland, and Spain, other countries have seen massive increases in household debt-to-income (DTI) ratios. In some cases, the levels have surpassed the 2008 housing crisis peaks. Advanced economies such as Australia, Sweden, Canada, and the Netherlands are included in this group. Debt is also heavily concentrated in mortgages (74% of household debt).
- China’s Debt Explosion – China’s considerable economic growth has been accompanied by massive debt increases. The debt has increased four-fold since 2007, reaching $28 trillion and blowing past the U.S. national debt of $18 trillion and change. Much of this debt is supported by real estate dealings (affecting approximately half of all Chinese loans) and an unregulated “shadow banking” system. Pile increasing government debt on top of that, and it would not be surprising to see a Chinese government bailout akin to several of the Western models.
We have to ask ourselves… is debt-driven growth an artifact of a temporary economic slowdown, or the new normal that we should expect? (To use a rural analogy, it is taking increasing amounts of water to prime the pump.) If so, how do we keep that debt from eventually causing economic collapse?
The MGI report does not assert that the rising debt is bad, but it does conclude that if higher levels of debt are necessary to promote economic growth, fiscal policies may need to change worldwide to manage the increased risk. Defaults and credit bubbles will always be present, but they must be prevented from snowballing and creating disproportionate economic damage. Creative debt restructuring may be required. Let’s hope that governments, regulators, and central banks are up to the task.