Economic and Financial Market Update: The Debt Song

Summary:

• Too much debt is an often cited concern about the global economy;

• Some countries have too much debt, some have too little;

• The most significant rise in debt over recent years has been in China;

• How the Chinese Government deals with its debt problem will play a key role in how the global economy performs over the next decade;

• Most countries have at least one sector of their economy with a high debt level;

• In Australia’s case that is household debt.  

With musicians it is about the heart, economists it is about the head. In music-land (Escape the Fate, Kim Wilde, Jessie J) the most popular topic with a four-letter word  is probably love. For economists it would be debt. This is particularly the case over recent years when an often cited concern about the global economy is the high level of debt. 

By a number of measurements global debt (relative to the size of global income) is at a record high. That should not be a major surprise. After all if you have a record low level of interest rates it should be no surprise to find a record high level of debt. There is no rule that says global debt cannot rise above a certain point. But clearly the higher the debt the more vulnerable the global economy becomes.

The size of global debt relative to global GDP has not changed much over the past 3 years. The bulk of the runup of global debt took place prior to the GFC. Following a (very gentle) period of deleveraging, the rise in debt between 2012-15 has been (relatively) modest.

The global debt story of the past decade is that banks have deleveraged following the problems exposed during the GFC. Reflecting the need to support their domestic economy (and in some countries to refinance their banking systems) there has been a significant rise of government debt. There has also been a modest increase in corporate debt. But the low rate of global productivity growth suggests that much of the rise in corporate debt has not gone into productive investments (in the US companies have been using cheap debt to repurchase shares to boost shareholder returns). The most eye-catching statistic from an Australian standpoint is that there has been no change in global household debt over the past decade.

Concerns about debt differ between countries. Three OECD economies have relatively low debt (less than 300% of GDP, New Zealand is likely a fourth), and seven with high debt (above 400% of GDP, and excludes financial centres such as Luxembourg). When it comes to total economy debt by OECD standards Australia is a goody-two-shoes. 

But having very low debt is not necessarily a good thing. The data suggests that Germany has the lowest debt ratio. But the German economy has been slowing as a result of the economic weakness in China as well as the Trade War. The German Government has the ability to borrow more to support the economy. And reports of deteriorating infrastructure suggests that they also have plenty of good ways they could spend the money (they don’t borrow more because there was a constitutional amendment requiring a balanced Government budget unless there is a natural disaster or a deep recession).

Conceptually, richer countries (those with the highest incomes per person) can afford to have more debt. And practically that does happen. By global standards the Australian economy has a relatively modest level of debt given the level of its income. By contrast Chinese economy has a high level of debt.

Most countries are carrying relatively high debt in at least one sector of their economy. Most common it is government debt. In the case of Australia it is a high level of household debt. 

The biggest decline in debt over the past decade have been amongst the countries that were hit hardest during the GFC (Portugal, Spain, Ireland, the UK and the US). The Germans and Austrians reduced leverage in their banking system, the part of their economy that was most vulnerable during the GFC. The exception has been Greece, where Government debt relative to the size of the economy has risen significantly over the past decade. That is partly because the Government has needed to spend to provide support to the economy. But a very weak economy has also meant there has been very low tax revenue.

The rise in debt over the past decade has been most pronounced in China. There has been a particularly big increase in corporate debt, but also household borrowing (where the increase over the past ten years has been greater than in Australia). The historical experience has been that whenever there has been a ‘borrowing binge’ at the pace seen in China over the past decade it has typically led to an economic slowdown (too much has been borrowed too quickly that has been most likely invested in bad assets). 

China is aware that the rise in debt is unsustainable and has put in place policies to try and fix the problem. China has a large amount of saving and so has the ability to absorb bad debts. Also, it is easier for the Government to deal with the problem as most of the Chinese borrowing has been from Chinese lenders. This is particularly the case given the significant role that the government still plays in the economy. 

Nonetheless, the bigger the debt buildup, the bigger the problem. And we are reaching the point whereby China is starting to have to import savings to fund all of its investment. This is happening at the same time as the Chinese financial system is opening up to global capital flows. The global trade war is a key risk to the global economy. But how China deals with its economic growing pains of too much debt is probably an even bigger one. 

The love of debt has been a big part of the global economy story for much of the past forty years. Hopefully that romance does not come to a bad end. Because if it does, as Neil Sadaka would put it ‘Breaking up is hard to do’.

We really do live in interesting times.

Peter Munckton - Chief Economist