Investors keep staying on the sidelines due to one very popular or rather unpopular narrative: the global debt bomb exploding.
For years now, fearmongering headlines on the subject continue to stoke investor anxiety.
When debt levels skyrocketed in 2019, so did headlines like, “Titanic iceberg of world debt could sink a slowing global economy”.
As the last decade of the 2010s wound down, year-end predictions and warnings multiplied with December 2019 registering several doom and gloom debt bomb headlines.
On December 1, 2019, Bloomberg postulated, “The Way Out for a World Economy Hooked on Debt? More Debt.”
A day later, the South China Morning Post warned, “Huge public, corporate and household debt looks like the ‘new normal’ for the global economy – until the next crisis.”
On December 20, 2019, ABC News’ top story was, “The World Bank warns a ‘wave of debt’ could swamp global economy.”
“Buckle up for turbulence: why a global debt crisis looks very hard to avoid” as The Conversation, an academic website, pronounced.
And in Britain, The Guardian on January 4, 2020, fretted, “Debt will kill the global economy. But it seems no one cares.”
How Debts Are Getting Out of Control
ABC News’ article started out, “The World Bank has warned the largest and fastest rise in global debt in half a century could lead to another financial crisis as the world economy slows.”
Citing the World Bank’s ‘Global Waves of Debt’ report, which looked at four major episodes of debt increases in 100 countries since 1970, the first being the Latin American debt crisis of the 1980s, then the Asian financial crisis of the late 1990s, and then the global financial crisis from 2007 to 2009, the report revealed that during the “fourth wave” from 2010 to 2019 the debt to GDP ratio of developing countries rose by more than half to 168%.
We’ll break down those exact numbers country by country shortly.
The report also shows that the rise of debt across both private companies and governments around the world could be “amplifying the risks if there is another global financial crisis.”
Global debt surged by US$7.5 trillion in just the first half of 2019, reaching a record US$251 trillion, according to the Institute of International Finance (IIF).
The IIF estimates total global debt will have exceeded US$255 trillion at the end of 2019 and calls the increase, largely driven by the U.S. and China, “mind-boggling.”
Moody’s, one of the big credit rating agencies, is notably worried about prospects for the world’s debt in 2020. After reviewing Moody’s latest ratings forecasts, an analyst said, “If we were to try to capture the agency’s view of where we are heading on a palette of colours, we would be pointing at black – pitch black.”
Citing politics in sovereign states and at the international level, Moody’s believes “slow-motion stagnation” of global GDP growth will be increasingly compounded by unresolved structural issues including: aging populations, income inequality, low currency reserves and poor government debt management.
Sovereign Debt Leads the Pack
International Monetary Fund (IMF) data points to 32 “high risk” countries with unsustainable debt, where government borrowing more than tripled in the last two years.
To make matters worse, countries with large account deficits who are overly reliant on foreign capital (including Argentina, Lebanon, Mongolia, Pakistan, Sri Lanka, Tunisia, Turkey and Indonesia) could quickly see capital flight at the first whiff of a panic.
This alone would have a four-fold effect: sending their currencies plummeting, making their foreign currency-denominated debts more unsustainable, triggering a default or at least a partial default a la Russia in 1998, and fanning contagion prospects.
Sovereign debt is only part of the problem.
Last October, the International Monetary Fund said almost 40% of the corporate debt in eight leading countries – the U.S., China, Japan, Germany, Britain, France, Italy and Spain – would “become so expensive during a recession that it would be impossible to service.”
Firms unable to cover debt servicing costs from operating profits over an extended period, currently experiencing lackluster or non-existent growth prospects, have risen to around 6% of non-financial listed companies in advanced economies, a multi-decade high, according to the Bank for International Settlements.
Adding to worries, the IMF says that the risks are “elevated” in eight countries with systemically important financial sectors.
The Build-up of Household Debt Is Mounting
Household debt to GDP hit 94% of GDP in South Korea in mid-2019, 84% in the U.K., and 74% in the U.S.
Debt ratios also stand at a high 74% Hong Kong, 69% in Thailand, and 68% in Malaysia. China’s household debt ratio is a more prudent 54%.
Rising household debt burdens, especially in the U.S. and parts of Asia, implies consumption booms are largely debt driven.
If stressed households get squeezed by rising rates or an economic downturn, the engines of consumer confidence (consumer spending and production) could sputter, which would trigger a negative feedback loop that leads to rising delinquency rates, personal bankruptcies, bad debt write-downs, and all manner of knockoff effects.
“What, me worry?”
But not much, or any of the above has happened, which means the global debt bomb narrative is just that, a narrative, a story without an ending, at least not yet.
And head honchos on Wall Street intend to ride the “not-yet” narratives.
Despite the rolling negative narratives including global debt bomb headlines, a drastic fourth quarter for stocks in 2018, and testy market bumps in May, August, and October of 2019, the consensus outlook for global economies and markets in 2020 is surprisingly upbeat.
And while geopolitical tremors just registered on investors’ Richter scale and are a longstanding narrative that looks to be coming to life, saber-rattling over Mideast issues hasn’t sunk any economy in years and hasn’t done more to markets than bruise them temporarily.
Analysts and investors’ fears of an escalating U.S.-China trade war are mostly in the rearview mirror with “Phase I” being readied for signing, just as global growth looks to be bottoming out and bouncing.
The International Monetary Fund is forecasting 2020 global growth of 3.4%. The World Bank is forecasting 2.7% growth.
The principal driver of analysts’ optimism is the accommodative approach taken by central banks around the world, generally to offset trade war concerns and falling investment in 2019.
The New Normal Is Nothing to Scoff At
But there’s a lot more going on than central banks’ 2019 easing moves.
The “lower for longer” mantra seems to be an almost articulated policy proscription, even though some central banks aren’t openly waving green flags after rate decision meetings.
In the “new normal” economic world, where central banks unapologetically monetize government debt, lavish their constituent banks with risk-free interest bearing excess reserve accounts, and write put options for equity markets, trade wars don’t really matter, financial engineering is cheap, and earnings and lackluster investment have a long runway to take off.
So, stock prices can keep climbing, and record global debt is nothing to lose sleep over.
Some analysts even contend that debt is gaining intellectual respectability, as are some leading economists, including Olivier Blanchard, a former chief economist at the IMF and now a senior fellow at the Peterson Institute for International Economics in Washington.
In keeping with modern monetary theory, they argue that any government able to issue their own currencies can and should borrow freely to finance fiscal stimulus as long as their central banks keep interest low.
With negative narratives at bay, interest rates lower for longer, fiscal stimulus being readied, and global debt essentially being floated, equities are likely to keep going up, and up, and up.
That’s because it’s all good, until it isn’t.