Monday, February 23, 2015

The end of extend and pretend

Facing up to $200trn in global debt.

They say that the instinctive response to danger is fight or flight. But there is a third – being frozen in awe.

That appears to have been the world’s response to what must be one of the most threatening economic issues of our time – the unprecedented level of global debt. It may also explain the scant attention that the latest data, researched and published by McKinsey Global Institute, has received after its recent release. Collated to cover the main economies of the world, it paints a rather dismal picture of the world’s debt burden.

Debt is to an economy what fertiliser is to a plant. Spreading some around will enhance its growth. A little more may encourage greater growth. But when you get to a point where you are virtually covering the plant it becomes counter-productive. And when you submerge the plant in three or four layers of it, you will most likely kill the plant. When the debt of an economy is three or four times its gross domestic product (GDP), there is little chance that an economy can grow out of it. The production of goods and services is the root of the economic plant and the basis of debt redemption.

That is a frightening prospect. It is rapidly spelling an end to the approach of extending the debt and pretending that it will take care of itself in future. Not all are predicting doom, but a greater number are certainly expressing gloom and real concern about the ability of nations to effectively deal with the problem.

Of key concern is that typically recessions lead to deleveraging, or a reduction in debt levels. This has not happened since the great recession of 2007 and debt has risen by $57trn, or more than 40% to $199trn. Only five nations, the most significant of which is Argentina, deleveraged in that period. All of the rest of the 47 countries surveyed showed increased debt to GDP ratios. Debt now equals 286% of global GDP, compared with 269% in 2007. McKinsey points out that “High debt levels, whether in the public or private sector, have historically placed a drag on growth and raised the risk of financial crises that spark deep economic recessions.”

This is what happened in 2007 and instead of debt reduction we have simply seen a massive increase through monetary instruments such as lower interest rates and quantitative easing. Yet these have consistently failed to pull economies out of low growth, at least in part because of its large application in assets such as stocks, bonds and property, and not fuelling consumer demand or being earmarked for investment in production.

Our inability to learn from the past must be one of the most inexplicable features of recent economics. Japan has had fruitless successive quantitative easing for some years. The US did the same, and it is still too early to conclude whether its recent improved performance can be attributed to monetary policies or simply a natural cyclical rebound. Europe is now also applying these policies and no doubt others will follow, perhaps even some in the developing world such as China.

Increased interest rates are an important tool in reducing debt. While it is generally expected that the US will start raising interest rates by the middle of this year, many would not bet on it. Given the global currency war, the still fragile state of economic recovery and pressure on the Fed, the latter has a good excuse to delay such a move for as long as possible.


The McKinsey analysis shows a significant shift in debt from other sectors into government. Government debt has increased by nearly 10% a year since 2007, compared with the 5.3% annual growth in all sectors and less than 3% annual growth in household debt. The world’s biggest debtor nation is Japan at 517% of GDP with much of Europe (apart from Germany) and the US having total debt levels of between 300% and 400%.

The growth of China’s debt, now at 282% of GDP is an alarming addition to severely indebted nations. Most of the developing countries still have relatively low debt to GDP ratios. South Africa is a case in point. It ranks 32nd out of the 47 countries with a ratio of 133% (excluding financial services debt). This was a 19% increase over 2007, with government indebtedness showing the biggest rise (18%) and corporate debt only 2%. Household debt actually declined by 2% and financial sector debt by 3%.

But South Africa also proves the point that statistics on their own say very little. A key consideration is not only the level of debt, but the nation’s ability to pay for it. Given severe structural, infra-structural, energy, labour and government efficiency constraints, the South African picture is certainly not a rosy one.

Clearly the days of extend and pretend are rapidly drawing to a close, if we have not passed that point already. So is calamity just around the corner? McKinsey believes it can be avoided or alleviated. One positive sign is that growth in financial services credit has slowed, specifically as a result of new regulations and controls. It suggests among others the introduction of new tools to create, manage, and monitor debt; better bankruptcy and restructuring processes; asset sales and tax policies that do not unduly favour debt.

Austerity seems to be the only answer policy makers have, but the austerity warriors may also be facing their last days on the battlefield. Already there is such popular dissent against austerity that is has become politically implausible. It has changed governments such as in Greece, and anti-austerity demonstrations have been filling the streets of many European countries including the UK. There is some justification for the outrage. The shift in debt from other sectors to governments shown in the above chart, reflects in large measure bail-outs which now have to be paid for by average tax payers.

It may be stretching a point to connect the dots between increasing economic insecurity and the many violent conflicts across the globe. At the very least austerity and democracy are now clearly in conflict.


  1. A superbly rational if disturbing analysis Jerry. Given these insights, those hoping to survive and thrive need to plan for what seems an inevitable meltdown. The 2007 recession seems fairly innocuous compared to the doomsday scenario you imply. Or do we read too much into your lines?

  2. Thank you Jerry. "a stitch in time saves nine" (forewarned)