Global debt has increased by $57tn since 2007 to almost $200tn - What happened to deleveraging?

Debt mountains spark fears of another crisis - FT.com

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The
world is awash with more debt than before the global financial crisis
erupted in 2007, with China’s debt relative to its economic size now
exceeding US levels, according to a report.

Global debt has increased by $57tn since 2007 to almost $200tn — far outpacing economic growth,
calculates McKinsey & Co, the consultancy. As a share of gross
domestic product, debt has risen from 270 per cent to 286 per cent.

McKinsey’s survey of debt across 47 countries — illustrated in an FT interactive graphic
— highlights how hopes that the turmoil of the past eight years would
spur widespread “deleveraging” to safer levels of indebtedness were
misplaced. The report calls for “fresh approaches” to preventing future
debt crises.

“Overall debt relative to gross domestic product is
now higher in most nations than it was before the crisis,” McKinsey
reports. “Higher levels of debt pose questions about financial
stability.”

Overall, almost half of the increase in global debt
since 2007 was in developing economies, but a third was the result of
higher government debt levels in advanced economies. Households have
also increased debt levels across economies — the most notable
exceptions being crisis-hit countries such as Ireland and the US.

“There
are few indications that the current trajectory of rising leverage will
change,” the report says. “This calls into question basic assumptions
about debt and deleveraging and the adequacy of tools available to
manage debt and avoid future crises.”

Countries that McKinsey
warns face “potential vulnerabilities” because of high household debt
include the Netherlands, South Korea, Canada, Sweden, Australia,
Malalysia and Thailand. “It is like a balloon. If you squeeze debt in
one place, it pops up somewhere else in the system,” says Richard Dobbs,
one of the report’s authors.

One “bright spot,” McKinsey says, is evidence of deleveraging by banks.
Financial sector debt relative to GDP has declined in the US and a few
other crisis-hit countries, and stabilised in other advanced economies.

Interactive

Global debt levels

The world is awash with even more debt than before the financial crisis. This interactive tool compares countries’ debt levels

Explore graphic

 

China’s total debt,
including the financial sector, has nearly quadrupled since 2007 to the
equivalent of 282 per cent of GDP. That was higher than in the US —
although China is lower if financial sector debt is excluded to avoid
double counting. McKinsey warns of risks in China’s property sector,
local government financing and a rapidly expanding “shadow” banking
system.

The country’s overall debt “appears manageable”, McKinsey
says, but its indebtedness would restrict its ability to compensate for
slower long-term growth in advanced economies.

“Before the
[post-2007] crisis there was one area where debt was very low and
stable, and that was China,” says Luigi Buttiglione, head of global
strategy at hedge fund Brevan Howard and co-author of a report in
September on global indebtedness. “When there was a crisis in the west,
China could lever up. Now that is not the case.”

The report is
likely to fuel debates among economists about what is an appropriate
level of debt in an economy. McKinsey argues much of the expansion in
developing countries has reflected the healthy development of financial
markets, but in advanced economies high debt could constrain growth and
create fresh financial vulnerabilities.

High debt levels could
make it harder for central banks to “normalise” monetary policy without
disrupting the real economy — the US Federal Reserve plans to raise
interest rates this year for the first time since 2006. “High debt
levels are an outward sign of structural problems,” says Charles Dumas,
chairman of Lombard Street Research.

The report comes as Greece this week has
pushed for a radical rethink by its creditors of ways of tackling its
debt and economic problems. Among the “fresh approaches” McKinsey
suggests are innovations in mortgages and other debt contracts to better
share risks between borrowers and creditors. Other steps it discusses
to prevent future crises include debt reschedulings and even writing off
debt bought by central banks under “quantitative easing” programmes.

If
debt held by government agencies and the central bank were excluded,
Japan’s government debt to GDP ratio would fall from 234 per cent to 94
per cent. But such quick-fix “deleveraging” could itself cause financial
turmoil, McKinsey acknowledges.

McKinsey’s conclusions echo
warnings by the Bank for International Settlements in Basel, which acts
as a think-tank for central bankers. BIS research had found that “when
private sector credit-to-GDP ratios are significantly above their
long-term trend, banking strains are likely to follow within three
years”, Jaime Caruana, BIS general manager, said in a speech late last
year.

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