Disappearing deleveraging, followed by debt, debt and more debt

It has been seven years since a credit bubble caused the worst financial crisis since the Great Depression; plenty of time to begin to get the economic house in order, but somehow global debt continues to grow. A new report from the McKinsey Global Institute highlights that, rather than deleveraging (reducing debt), all major economies today actually have greater borrowing relative to GDP than they did in 2007.

The report notes that global debt has increased by $57 trillion over the last seven years, pushing the ratio of debt to GDP up by an alarming 17%. Authors Richard Dobbs et al. highlight the potential consequences of the huge growth in global debt, saying: “That [this situation] poses new risks to financial stability and may undermine global economic growth.”

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Global debt and the deleveraging that never happened

Virtually all economists and policy makers were expecting a large-scale global deleveraging after the financial crisis of 2008 -2009 began to unfold. The seizing up of the global financial system meant there was little to no money available to borrow, so everyone naturally assumed lending would dry up. And it did…for a little while. Then the Fed and other governments began loosening the fiscal purse strings and the borrowing began and hasn’t stopped since.

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Government debt is unsustainable in some countries

Dobbs and colleagues note that government debt has increased by $25 trillion over the last seven years. Moreover, it will inevitably continue to increase in many nations due to the current economic reality. World leaders authorized much of this debt to finance bailouts and stimulus programs to fight off the crisis. Debt also increased due to the recession and ensuing weak recovery.

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The report also points out the reality that for six of the most highly indebted countries, the process of deleveraging means impossibly high economic growth or politically impossible fiscal adjustments. The authors argue that countries need to consider new approaches to debt reduction, such as “more extensive asset sales, one-time taxes on wealth, and more efficient debt-restructuring programs.”

Household debt is growing rapidly

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The McKinsey report highlights that consumer deleveraging only occurred to an appreciable extent in Ireland, Spain, the UK and the U.S. In most other countries, household debt-to-income ratios continue to move up. In fact, household debt-to-income ratios are well above the peak levels in the crisis countries before 2008 in some cases, including in Australia, Canada, Denmark, Sweden, and the Netherlands, as well as Malaysia, South Korea, and Thailand.

Dobbs et al. note that if “these countries want to avoid property-related debt crises like those of 2008. To manage high levels of household debt safely, they need more flexible mortgage contracts, clearer personal-bankruptcy rules, and tighter lending standards and macroprudential rules.”

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China’s debt up 400% since 2007

In another potential danger to the global economy, China’s total debt has nearly quadrupled, increasing from $7 trillion to over $28 trillion in the 7.5 years from 2007 to mid-2014. Standing at 282% of GDP, China’s debt as a share of GDP is actually greater than that of the United States or Germany.

The report focuses on three potential problem areas: 50% of lending activity is related to China’s overheated real-estate market; unregulated shadow banking now represents nearly half of new lending; and a good bit of unsustainable local government debt. That said, MCKinsey calculates that the Chinese government has the can bail out the financial sector if/when a real estate-related debt crisis develops. They argue that “The challenge will be to contain future debt increases and reduce the risks of such a crisis, without putting the brakes on economic growth.”

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