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The Growing Concern: Global Debt Levels
“You can’t solve a debt problem by adding more debt,” emphasizes a well-known market saying. In recent decades, global debt has ballooned to nearly three times the size of the world economy, significantly more than the levels recorded four decades ago. This exponential growth prompts serious questions: Are we on the brink of a debt crisis?
Recent Credit Episodes
Notable “credit episodes” have surfaced recently, with alarming cases arising in companies like First Brands and Tricolor in the U.S., as well as the Chinese property giant Vanke and Swedish battery maker Northvolt. On a banking level, institutions such as Silicon Valley Bank and Credit Suisse have also seen dramatic situations unfold. Concerningly, despite the restructuring of Greece’s sovereign debt being behind us, public debt has reached unprecedented levels, matching those not seen since World War II. In the U.S., public debt is nearing 100% of GDP, coupled with structural deficits of about 6%. This trajectory suggests that if trends continue, the U.S. may soon eclipse its historical debt highs.
Alarmist Perspectives on a Debt Crisis
With rising global debt, alarmist narratives about an imminent “debt crisis” proliferate. Human history suggests that such alarms can galvanize societies, a sentiment rooted in our evolutionary past. Yet, we must consider whether these fears are rational.
Examining Global Debt Truths
Interestingly, while global debt figures sound alarming, the reality lies in the understanding of debt composition. The reported figure of three times GDP incorporates debts from households, companies, governments, and banking systems. It’s essential to recognize that this includes double counting; for instance, when a mortgage is counted both as a personal debt and as a liability of the bank. Eliminating this double counting can lower the reported global debt by around 75% of GDP, suggesting that net debt may be significantly less daunting.
Understanding Credit Risks
Recent credit episodes in the U.S. often stem from fraud rather than systemic risks. For risks to be systemic, there needs to be a substantial increase in corporate debt accompanied by spikes in credit spreads. Currently, private debt in the U.S. stands at healthy levels of 1.4 times GDP, compared to 1.7 in 2008. Similar figures exist in Europe, with private debts at 1.5 times GDP. Low credit spreads underscore this stability.
The Evolving Landscape of Debt
Current U.S. debt yields around 4.1% over 10 years, dropping from 4.5% a year ago. With low bankruptcy risks across many OECD countries, including a stark decline in the risk premium for nations like Spain and Greece, it raises the question: if public debt is so astronomical, why are yields declining? The sharp reduction in private debt in the West mitigates the danger of public sector bailouts for the private sector. Overall, the West’s banking system has achieved a stability not seen a decade ago.
Deciphering Shadow Banking
Worries surrounding “shadow banking” often misrepresent the sector. Predominantly comprised of established entities like insurance companies and investment funds, shadow banking encompasses assets totaling nearly $250 trillion. Most of its assets stem from traditional investment channels, limiting systemic risks. Hedge funds and private credit institutions have structured their liabilities to discourage rapid withdrawals, further reducing risk profiles.
Conclusion: Rethinking Debt Crisis Narratives
Warren Buffet wisely noted, “To get there first, you have to get there first,” suggesting that excessive debt can be harmful. Overall, while the narrative surrounding a potential debt crisis raises valid concerns, the systemic risks in the West may be less severe than sensational headlines imply. Perhaps it’s time to switch our focus from alarmist warnings to a more rational understanding of global debt realities.
Ignatius of the Tower is Chief Economist at Arcano and a professor at IE.