All Financial Wisdom

The gigantic ball of global debt that should worry us

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The global debt is at historic highs, reaching a total of $164 trillion dollars in 2016, which is equivalent to 225% of world GDP. The world is now 12 percentage points more indebted than the previous peak in 2009, with China is a catalyst for this debt.

Public debt plays an important role in global debt, due to the economic collapse during the global financial crisis and the policy response, as well as the effects of the fall in commodity prices in 2014 and the rapid increase in spending on the case of emerging markets and low-income developing countries.

As can be seen in the following graph, and on CNBC, the public debt of the developed economies stands at 105% of GDP, average levels not seen since the Second World War. In emerging markets and middle-income economies, debt is close to 60% of GDP at levels seen for the last time during the debt crisis of the 1980s. For developing countries, the average proportions of debt in relation to GDP have been rising at a rapid pace and increased by 40% since 2017.
Which countries are mainly responsible for the high debt?

In absolute terms, the 164.4 trillion dollars were distributed as follows: 119.2 trillion between advanced economies, 43.9 trillion between emerging economies and 1.3 billion between developing economies with low incomes.

US – Japan

It should be noted that three countries account for half of the global debt: the United States (48.1 trillion), China (25.5 trillion dollars) and Japan (18.2 trillion dollars). This is a picture of the moment, but if we focus on dynamic terms, compared to 2007, the United States and China have been the great catalysts of debt.

In the case of the United States, in 2007 it assumed debt levels of 33.6 trillion dollars, which means that, after nine years, the debt has skyrocketed by 43%. Also, with Trump’s current policy it does not seem that the deficit will be controlled, so we should see increases in its public debt.

In contrast, both in absolute terms and relative to the year 2007, China takes the cake. If at the beginning of the Great Recession, China showed a debt of 4.9 trillion dollars, in 2016, it added an additional 20.6 trillion to its debt, which represents an increase of 420%, due to a policy of low interest rates – interest to stimulate the domestic demand of the country.

Why should we worry about high levels of debt?

There are several reasons why high public debt and deficits are causes for concern and should motivate countries to create buffers by reducing deficits and debt on a steady downward path.

High public debt can make countries vulnerable to the risk of refinancing due to the large amount of financing needs, especially when maturities are short.

As happened to Greece, market access could be disrupted if financing conditions are sharply shortened or if there is a change in investor sentiment that leads them to reject Treasury issues.

A high debt / GDP ratio could cause an increase in risk premiums if investors become skeptical about a country’s ability or willingness to pay, even for reasons of concern with the political viability of fiscal policies.

Countries may be subject to large unexpected disturbances in the levels of public debt relative to GDP, which would exacerbate the risk of refinancing. In fact, based on a sample of 179 episodes of debt peaks in 90 advanced countries in emerging markets and low-income developing countries, they find that the biggest driver of public debt peaks are not the primary deficits, but the GDP contractions or higher interest payments.

Also, high levels of public debt hinder the capacity to carry out public spending needs due to the fall of income in the context of financial crisis. The combination of excessive levels of public and private debt can be very dangerous in the event of recession as tax increases are incurred to collect the loss of income, reducing the disposable income of families in a complex situation.

But Japan does not seem to have problems with the highest public debt on GDP in the world

Many could underestimate the importance of the debt levels, pointing to Japan that currently has a public debt to GDP ratio of 236%, being the highest ratio in the world and the country, to date, has not gone bankrupt.

To understand the situation in Japan, one must go back to the housing bubble at the beginning of the 1990s. Once the stock market collapsed and stock prices fell, banks and insurance companies were left with high delinquency.

The government and the Japanese central bank supported these organizations by rescuing them and offering loans at low interest rates. Therefore, these companies relied exclusively on support but this eventually became unsustainable, so some entities were finally nationalized.

Over many years, other fiscal stimulus initiatives were also used to help reactivate the faltering economy. Due to these measures approved by the government, Japan’s debt level soared to become the highest in the world.

There is an interesting point in Japan that contrasts with other countries and that explains why the country has not fallen into default. You see most of Japan’s debt (including government bonds) is in the hands of their own citizens, so the risk of default is limited.

At the same time, an environment of historical deflation or low inflation comes into play, if prices fall and bonds offer positive returns, real profitability increases.

But from here the problems begin … The country has to increase national savings so that domestic buyers continue buying new public debt. However, the population of Japan is declining and aging, so it is very doubtful that the country can increase national savings to a point where the purchase of government bonds is sustainable and will necessarily need foreign investors if it does not intend to enter into default. This will not end well

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