Another record for the history books.
In addition to reporting on the dangers facing global banks as a result of declining profits in the current low rate environment, today the IMF also released its latest Fiscal Monitor report which sounded a loud alarm when it revealed something disturbing: at 225 percent of world GDP, the global debt of the nonfinancial sector, comprising the general government, households, and nonfinancial firms, is currently at an all-time high of $152 trillion.
Add financial debt and you will need a far bigger chart.
With global nonfin debt/GDP growing from 200% in 2002 to 225% in 2015, it is obvious that debt growth has vastly outpaced the rate of economic growth as a result of the collapsing marginal value of every dollar of debt which result in increasingly less “bang for the growth buck.”
As the IMF warns, “two-thirds, amounting to about $100 trillion, consists of liabilities of the private sector which, as documented in an extensive literature, can carry great risks when they reach excessive levels. However, there is considerable heterogeneity, as not all countries are in the same phase of the debt cycle, nor do they face the same risks. Nevertheless, there are concerns that the sheer size of debt could set the stage for an unprecedented private deleveraging process that could thwart the fragile economic recovery.”
There’s no consensus on what levels of debt-to-GDP should be the considered alarming – we would guess that 225% qualifies – the IMF said. However, financial crises tend to be associated with excessive private debt in both advanced and emerging economies, the fund said cited by BBG. In addition, research has shown that high debt is linked with lower growth, even when a crisis is avoided. If companies postpone paying off debt, they could become “very sensitive to shocks, increasing the risk of an abrupt deleveraging process,” the IMF said.
The IMF redundantly adds that resolving this “private debt overhang” problem is, however, not easy in the current global environment of low nominal output growth. As we have warned for years, the ever growing size of the global debt burden not only highlights the difficulty of boosting the international economy at a time when borrowing, particularly by corporates, has already reached unprecedented levels, but also the reason why central banks are extremely limited how high they can push interest rates, as this unprecedented debt load is only sustainable as long as the interest expense associated with is still somewhat manageable, forcing record low rates, which in turn leads to even more debt issuance, and so on in a toxic feedback loop.
The International Monetary Fund also points out another obvious feature of debt which can bever be repaid: it leads to crises.
New empirical evidence confirms that financial crises tend to be associated with excessive private debt levels in both advanced and emerging market economies, but high public debt is not without its risks. In particular, entering a financial crisis with a weak fiscal position exacerbates the depth and duration of the ensuing recession. The reason is that the absence of fiscal buffers prior to the crisis significantly curtails the ability to conduct countercyclical fiscal policy, especially in emerging market economies. These results argue for strengthening the government balance sheet in upturns, while adequately accounting for financial cycles when assessing a country’s fiscal position, and ensuring the close monitoring of private debt through adequate regulatory and supervisory frameworks. This is particularly relevant in emerging markets where private sector leverage has increased significantly over the past few years.
Clearly, even the IMF is now well aware that absent a major global deleveraging, growth is doomed to stagnate until an event occurs that forces the world to tackle its debt problems head on.
What can be done to address this dramatic overhang. Here are its two ideas:
Reductions in gross debt ratios can come from two sources: macroeconomic deleveraging (through growth and inflation) and balance sheet deleveraging (through debt repayment, restructuring, and write-downs) Fiscal policy can help with both:
Macroeconomic deleveraging. Countries with slower nominal growth will take longer to escape a debt overhang problem (Reinhart, Reinhart, and Rogoff 2012). Therefore, demand management policies and, in particular, fiscal stimuli geared toward supporting economic activity can aid in the deleveraging process.
Balance sheet deleveraging. When the debt overhang is severe, balance sheets may also need to be cleaned up. Unfortunately, without government intervention, balance sheet repair often proceeds very slowly, because of coordination problems, market failures, and the inability of distressed banks to absorb losses (Laeven and Laryea 2009; Laryea 2010). However, leaving the debt overhang unaddressed can result in lower consumption and underinvestment (Olney 1999; Myers 1977), which, if compounded by banks’ foregoing profitable lending opportunities (Philippon and Schnabl 2013), will weaken the recovery. This is an argument for targeted fiscal intervention to speed up the resolution of the debt overhang problem. These types of interventions are usually geared toward addressing weaknesses in the banking sector and typically include recapitalization, asset purchases, and sometimes guarantees. But they can also include measures to facilitate the repair of households’ and firms’ balance sheets. A government-sponsored debt-restructuring program in the latter case often includes subsidies for creditors for lengthening maturities, guarantees, or both and direct lending to companies that are viable but unable to access financial markets, as well as the creation of asset management companies.
The bolded section is also known as “kicking the bucket” and is precisely what China has been aggressively engaged in recently, following news that a quarter of its companies can not cover the interest expense on their debt.
The IMF believes that “At present, given the sheer size of the debt, particularly in some advanced economies, it is likely that a combination of macroeconomic and balance sheet deleveraging will be needed. The next section explores whether and how fiscal policy can help and the trade-offs involved.“
Ultimately, however, it will boil down to “growth-friendly fiscal policies”, or a clever way to say fix debt with more debt,calls for which have grown from the IMF and other multilateral institutions as concern has mounted that the world’s central banks have been left with too much of the burden to lift the global economy.
As the FT also notes, IMF director of fiscal affairs, Vitor Gaspar emphasised that debt levels were not high everywhere. “The sharp diversity across countries is a reminder of the need to tailor policy diagnosis and prescription to the specific conditions prevailing in each country,” he said. “Most of the debt is concentrated in the world’s richest economies, although China has markedly increased borrowing in recent years. While low income countries have relatively low levels of debt, many have sharply increased borrowing in recent years.”
At $152 trillion, global debt is at an all-time high, but not all countries are in the same phase of the debt cycle, nor do they face the same risks. In a few systemically important emerging market economies, private credit has expanded briskly in recent years. The speed of the increase dangerously resembles that in advanced economies in the run-up to the global financial crisis. In advanced economies, progress with private sector balance sheet repair has been mixed. Moreover, the interaction between the incipient deleveraging and low nominal growth has resulted in a vicious loop that in some cases, notably in Europe, has delayed the resolution of banks’ distressed assets, hampering the efficient flow of credit and further depressing output.
In those countries not yet facing a debt overhang problem, efforts should focus on curbing excessive private debt buildup and limiting spillovers to public sector balance sheets. This is particularly relevant in emerging markets where private sector leverage has increased significantly over the past few years. Countries should conduct countercyclical fiscal policy in upturns, thereby creating fiscal buffers that could be deployed if needed in times of crisis.
Which likely means that in the coming years the world will see another push to flood the world’s developing countries, as least those not already drowning in debt like China, to take on more leverage to allow the massively indebted developed world to keep growing at its customary pace.
In a curious proposa, the fund also said that companies would help lift growth if they shrank their balance sheets by reducing their size, although it acknowledged the process would take time.
“Excessive private debt is a major headwind against the global recovery and a risk to financial stability,” Mr Gaspar said. “The Fiscal Monitor shows that rapid increases in private debt often end up in financial crises. Financial recessions are longer and deeper than normal recessions.”
The problem with that is that any decline in debt would lead to major pain for corporate equityholders, which likely means that such an avenue is impossible at least as long as the company is viable.
Gaspar also said that countries entering a financial recession with a weak fiscal position were likely to lose more growth than countries that manage to counter shocks by spending more, meaning they have more debt capacity. This explains why even the mere thought of China, with its 300% debt/GDP, entering a recession is enough to bring nightmares for any policy planner in the world today.