Conventional wisdom is that the U.S. recovery is well under way, with Europe not far behind, and that the Fed’s decision to delay tapering until the end of the year or longer was overly cautious. But Citi credit specialist Matt King thinks that the recovery has been fueled almost entirely by debt and that it is leading us into a dangerous boom/bust cycle.

High rate of U.S. debt

U.S. debt is still at an incredibly high rate as a percentage of GDP. That’s not to say there hasn’t been any deleveraging, but it has taken place almost entirely in the private sphere and has been offset by public leveraging. The reality is that we’re still at Great Depression era levels of debt.

US Debt leverage record highs 1013

private delev offset by public leveraging

Public leveraging

Some analysts have made the argument that this public leveraging is different because it was a conscious decision to spur economic growth, but that doesn’t address the issue of what happens next. Over the last few years, credit and equity markets have tracked Fed spending patterns, and there isn’t much reason to assume that has changed now. King argues that the U.S. economy’s dependence on debt has simply been papered over, and that it will reassert itself in the mid- to long-term.

never mind fundamentals

China’s credit bubble

And it’s not just the U.S. that is at risk. It has taken China more and more credit to sustain its high GDP growth. No one has a solid take on how much bad debt there really is (or how much debt will stop performing as the economy cools), and if the credit bubble pops the Chinese government probably won’t get the orderly slowdown they’ve been working so hard for. Arguments that the EU is ignoring fundamental problems surrounding sovereign debt and that Greece, possibly others, are completely unable to pay back their loans have become more common.

china growth real credit

Increased leveraging isn’t the whole story, but it is a consistent theme both in developed market recoveries and emerging market growth. King’s advice for people wondering how to approach developed markets that appear to be growing but clearly have underlying weaknesses?

“Buy the best seats for the next few concerts, but not the season ticket.”