Assessing the threat from ballooning debt
After the 2008‒09 financial crisis there was a lot of tough talk about reducing global debt levels. Unfortunately, during the past decade, debt levels have continued to rise steadily: from 2008 to 2018, debt levels rose to $250 trillion—an increase of roughly 43%. While slower than in the prior decade, debt growth was faster than GDP growth, and the ratio of debt to GDP rose from around 280% in 2008 to 320% in 2018.
Household and student loan debt
While the surge in household debt was one of the causes of the global financial crisis, this threat has since abated. Since 2008, the largest household sector deleveraging has occurred in the United States, the United Kingdom, Ireland, Portugal, Spain, and Germany. In other economies, such as Australia, Canada, Norway, Sweden, Finland, France, and South Korea, household debt ratios have continued to rise.
In the US, the rapid rise in student loans is a troubling counter-trend. According to data from the Federal Reserve Bank of New York, student debt is around $1.5 trillion, 11% of total household debt (compared with 67% for mortgages). These loans have grown by more than 180% since early 2007 (compared with only 8% for mortgages), and the delinquency rate of student loans is about 10 times higher than that for mortgages. While this type of debt does not pose the immediate systemic threat that mortgages did before the global financial crisis, it is causing substantial financial hardship for young college graduates and may be hurting market for first-time homebuyers.
While banks around the world are in generally better shape now than before the crisis, overall financial-sector risk has not fallen, it has migrated to under-regulated, nonbank financial institutions which continue to lend large amounts to nonfinancial corporations (NFCs). Arguably, the darkest spot in the post-crisis private-sector debt picture is the rapid rise in NFC liabilities, which increased nearly three-fold in the past decade. In the developed world, the annual growth rate has been around 8% while China's growth rate of corporate debt has been an eye-watering 40% per year. How China continues to deal with its huge corporate debt load is one of the imponderables facing the global economy: a well-managed deleveraging will help to engineer a smooth trajectory for the world's second-largest economy while a badly managed deleveraging could create enormous volatility in financial markets and damage growth prospects in many parts of the world.
US corporate debt has not risen as rapidly as China's—the NFC-debt-to-GDP ratio has risen from 40% to 46% (to around $9 trillion) in the past decade. Nevertheless, there is growing concern that this ratio is at a record high. There are also worries about the recent flood of "leveraged lending," syndicated loans to highly indebted companies (which have doubled in the past decade to around $1.2 trillion); and collateralized loan obligations (CLOs), packaged loans that are sliced and sold according to the risk appetite of investors. The biggest concern is that the most rapid increases in these types of corporate debt are concentrated among the riskiest firms, while credit standards have been deteriorating. Nevertheless, in an ultra-low interest-rate environment, the current volume of CLOs is probably not a systemic threat to global financial markets or the world economy. Once interest rates begin to rise, however, the risks of another meltdown will increase.
The net-debt ratio has stabilized in most developed economies over the past half-decade. This is not the case in the US, where debt held by the public as a percent of GDP rose from 39% in 2008 to 73% in 2014, and thanks to large fiscal stimulus put in place in early 2018, the US net-debt ratio is set to soar to 95% by 2029 and 103% by 2039.
For some mainstream economists, the US debt burden is not a source of concern, so long as the trend growth in nominal GDP (3.5% to 4.5%) exceeds long-term government borrowing costs (currently around 2.5%). But even with these benign trends, US government interest costs are likely to increase very rapidly, overshadowing other spending categories in the next couple of decades—and would rise even faster if long-term rates were to return to their early 2000s average of 4.0% to 5.0%. Moreover, with an aging population, the growth in the entitlement programs (especially Social Security and Medicare) will be more rapid than the growth in nominal GDP, putting significant upward pressure on the US debt ratio.
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