The world was pushed into a global recession when the US debt mountain collapsed in 2008. At present, overall debt burden relative to GDP is higher in India, Indonesia, Thailand, South Korea, China and Malaysia, up to 30% higher than in the US. What will be the effect if the global debt mountain has problems?
To almost no one’s surprise the US Federal Reserve (Fed) decided to continue its experimental bond buying known as Quantitative Easing or QE. The Fed is not alone. Since 2009 it is estimated that central banks all over the world pumped roughly $9 trillion into the world economy. This free money allowed governments; companies and private individuals borrow as never before. As a result the levels of debt have increased substantially.
Public debt in Organisation for Economic Co-operation and Development (OECD) countries as a percentage of GDP went from around 70% in the 1990s to 110% in 2012 and is expected to rise to 112.5% of GDP by 2014. Some of these debt figures are truly amazing. Portugal’s debt is 123% of GDP. In Italy the figure is 127%. Greece’s problems are well known. Their debt is 180% of GDP. In Japan, it is a whopping 246% of GDP. The US used to have a reasonable debt of 67% but that has now risen to 112% of GDP to over $17 trillion dollars, about $54,000 for every citizen.
Sovereign debt is not the only area that has grown substantially over the past five years. In the US, the record low interest rates allowed corporations to borrow as never before. In the past three years, non-financial US corporations have borrowed more than $1 trillion dollars. They now owe more than $14 trillion. Their debt is now 2.3 times annual corporate revenues. This is one of the highest levels recorded in history with one exception. The other time it was this high was during the dot.com bubble of 1999-2000.
The quality of debt has also changed recently. Usually there are standard ‘covenants’ or provisions to protect creditors. Before the crash in 2007, so called “cov-lite” loans became popular. These had fewer protections and were usually a disaster for the creditors when the loans went bad. Before the crash companies issued $100 billion in cov-lite loans. So far, in 2013 more than $200 billion of cov-lite loans have been issued. Usually they pay higher yields, which make them especially attractive in the era of cheap money.
Collateralized loan obligations (CLOs) became notorious after the crash. These special purpose vehicles (SPV) are made up of a pool of other loans, which are sliced and diced then packaged to provide different levels of risk. The level of risk was misrepresented by the credit agencies who were asked to rate them before they were sold. These have now made come back. There have been $55 billion sold this year. The highest since $88.94 billion were sold in 2007.
US consumers have been fairly frugal since the crash. Most have repaired their balance sheets, which are far less leveraged with one exception: student loans. In the US, there are $1 trillion student loans outstanding. After mortgages they are the second largest category of consumer debt. Unlike mortgages there is no collateral. Now, 11% or $110 billion are seriously delinquent, which means that they are at least 90 days past due.
The European sovereign debt crisis is well known. Even though it has, in theory, been stabilized, it does not mean that it is not still growing. Sovereign debt in Europe has grown significantly since 2007 despite several austerity programs. But it is not just sovereign debt. Unlike the US, Europe has failed to deal with its private debt. With the exception of Germany, private debt in Europe has increased since 2007. It is now beginning to show up, or more accurately discovered, as nonperforming loans. European banks’ nonperforming loans have doubled in four years to reach €1.2 trillion. They were €514 billion in 2008 and are now €1.187 trillion. Although much of these bad loans are located in the notorious periphery countries, Germany had the largest number of bad loans at €179 billion.
In contrast to the European countries, the BRIC countries have actually lowered their sovereign debt, but they are the exception in the emerging markets. However, even as the sovereign debt of the largest emerging markets has gone down, the growth of private debt has more than made up the difference. Emerging market bond sales have grown to about $1 trillion in size. It is now larger than the US junk bond market as an asset class.
Emerging market corporate bond sales have doubled since 2005 and are still growing rapidly. They reached a record of $200 billion last year. This record was surpassed last May. Much of the debt was in local currencies, but a lot was not. Emerging market companies accounted for 80% of hard currency debt sold in 2013.
In addition to bond sales, bank lending to emerging markets has also set records. It is now estimated to be about $3.4 trillion dollars. In the first quarter of 2013 alone, cross border bank lending to EMs rose to $267 billion.
Emerging market consumers have also been busy catching up to their more spendthrift cousins in developed countries. Non mortgage consumer debt is $1.6 trillion. Motor vehicle, large appliance, and electronic loans doubled while credit card loans grew 90%. Overall debt burden relative to GDP is higher in India, Indonesia, Thailand, South Korea, China and Malaysia, up to 30% higher than in the US. Consumer debt is so high that pawnbrokers are one of the fastest growing businesses in South East Asia. There are three listed on the Singapore stock exchange. The newest listed this week.
Brazil has developed a culture of installment payments or parcelas. Almost anything from shampoo to plastic surgery is available on instalments. The result is that the average family spends 20% of its monthly income paying off debt, handily beating American consumers who reached a record of 13.5% in 2007 and twice the present rate.
And last but certainly not least is China. China went on a debt binge to protect the country from the recession in 2008. It hasn’t stopped. Debt soared from 130% of GDP in 2008 to 200% today. Much of the stimulus was funnelled through to local governments who borrowed heavily to build infrastructure projects including many vanity projects. No one really knows the size of the debt. It could range anywhere from 15 trillion yuan to 30 trillion ($2.46 trillion to $4.92 trillion), which equals 30% to 60% of the GDP. The central government’s audit is supposed to be complete this month, but it is doubtful that they will release the real number.
In addition to the local governments, the Chinese also have 320 million credit cards. Their use has grown 400% in the past 6 years. Household debt is only half the level of government debt and a quarter of corporate debt but at 15 trillion yuan ($2.5 trillion) it isn’t a rounding error. It is only 50% of disposable income, not up to developed world levels, but it has tripled over the past 5 years.
The world was pushed into a global recession when the US debt mountain collapsed in 2008. What will the effect be this time if the global debt mountain has problems? The Federal Open Market Committee (FMOC) is responsible for the stimulus known as QE. Its membership will change on 1 January 2014, one incoming member, Charles Plosser, said the current round of QE will end at some point, though he won't give a timetable. Perhaps then we will find out.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)