ATHENS, GREECE - MAY 20: Greek riot police stand in formation at the Greek Parliament on May 20, ... [+]
Many Europeans will still be aware of the euro-zone debt crisis, and perhaps nervous when they hear that world debt to GDP is rising to historically very high levels. In the US, federal debt to GDP is at its highest in over 120 years (nearly 100 %) and projected to rise towards 200% by 2050 according to the Congressional Budget Office. In the UK, debt to GDP has also risen, to the highest level in seventy years.
During the period of quantitative easing (QE) that followed the global financial crisis and then the euro-zone crisis, low interest rates permitted the accumulation of debt, and also meant that markets were sufficiently awash with liquidity that they did not have to worry much about rising indebtedness.
QE caused indebtedness?
However, with inflation proving sticky and interest rates rising to historically high levels (US mortgage rates are over 7%) debt sustainability is now an issue, for some companies, households and countries. Add to that the downturn in the Chinese property sector, and the prospect of localised or a broad debt crisis is not remote.
This is not the market consensus view however – credit spreads are tight and there is a sense that a dip in economic activity should lower interest rates. At the same time this does not mean that debt levels can fall easily.
Historically, taking the US and UK as examples, when debt to GDP has risen above current levels it has usually been associated with wars (Napoleonic Wars, World War II) which in turn have either been associated with financial innovations or economic rebuilding. This time the COVID emergency and high levels of geopolitical tension provide the policy backdrop to indebtedness. Indeed, with the US government spending more on interest payments on its debt load than on the military, indebtedness has geopolitical implications.
Fiscal consolidation
It is likely that in many countries, high levels of government debt will eventually lead to fiscal consolidation, which may be politically difficult in countries like France where government spending is very high, in the face of a tough political backdrop. For companies and property markets (outside China) the outlook is more mixed and we reiterate one of our key themes for 2023 ‘the discovery effects of interest rates’.
This means that higher rates (for longer) will lead to a pronounced ‘winner’ v ‘loser’ effect where highly geared companies and real estate markets face consolidation. This process does not have to be disruptive across the economy, and should be facilitated by credit markets.
One of the few economies where we can say ‘this time is different’ is Ireland, whose debt trajectory is different to many other countries. At the end of 2012, debt to GDP was close to 300% but is now on course to hit 50% (debt to gross national income is closing in on 70%). This is due to both deleveraging and also to high growth. Its example opens up the argument that QE itself is not the only way to contain debt, but rather that growth is a better way forward.
