The key chart
The key message
With attention focusing mainly on post-pandemic highs in the level of global debt/debt ratios, it is very easy to ignore key changes in the structure of global debt, and why these changes matter.
- There has been a marked shift away from household (HH) debt to government debt, at the global level. While HH (and other types of private debt) typically cause crises, government debt typically ends them/reduces their severity. Government deficits also increase the supply of money and depress rates (contrary to popular opinion)
- The structure of US and UK debt is now the mirror image of the pre-GFC period. This reduces associated risks since governments face different financial constraints to the HH and NFC sectors and cannot, as currency issuers, become insolvent
- A similar but more muted shift has occurred in the euro area (EA) where the structure of debt also differs significantly across the EA’s largest economies
- As currency users, EA governments also face different constraints to governments that remain issuers of their own currency. Flaws in the EU’s fiscal architecture were apparent before the pandemic. With budget hawks already calling for a return to EU fiscal rules, policy risks remain elevated
- These trends are advanced economy trends not EM ones. With private sector credit accounting for 72% of EM debt, EMs face very different challenges associated mainly with the level of NFC debt and the rate of growth in HH debt (note also that EM debt is increasingly a “China-debt” story)
Global debt dynamics are a key element of CMMP analysis. It is natural to focus initially on the impact of responses to the pandemic on the level of debt. However, a failure to incorporate analysis of the structure, growth and affordability of debt at the same time can lead to false conclusions regarding investment implications. The post-COVID world is very different from the post-GFC world.
Structure matters too
Much attention has focused on the impact of the public and private sector responses to the COVID-19 pandemic on the level of global debt and global debt ratios across all sectors (see chart above). All recorded new highs at the end of 4Q20. Less attention has focused, however, on the changing structure of global debt particularly in relation to the pre-GFC period. This posts sets out to correct this by highlighting five key structural changes in global debt and explaining their significance.
Five key changes
First, at the global level, there has been a shift away from HH debt to government debt (see chart above). This matters because (1) while private sector debt typically causes crises, public sector debt typically ends them/reduces their severity and (2) contrary to mainstream teaching, government deficits increase rather than decrease the supply of money and drive rates down.
Second, following this shift, the structure of US and UK debt is the mirror image of the pre-GFC structure (see chart above). This reduces associated risks since governments face different financial constraints to the HH and NFC sectors and cannot, if currency issuers, become insolvent.
Third, more muted shifts have occurred in the euro area (EA) where the structure of debt still differs significantly across the EA’s largest economies. HH debt accounted for 27% of total EA debt in 1Q08 versus 42% in the US and the UK (see chart above). This share fell to 21% in 4Q20 versus 27% in the US and 30% in the UK respectively. Government debt has increases from 31% to 39% of EA debt versus 45% in the US and 44% in the UK respectively. At the country level, however, the share of government debt in total debt ranges from 60% in Italy to only 20% in the Netherlands (see chart below).
Fourth, as currency users, EA governments also face different constraints to governments that remain issuers of their own currency. Flaws in the EU’s fiscal architecture were apparent before the pandemic. With budget hawks already calling for a return to EU fiscal rules, policy risks remain elevated.
Fifth, these trends are advanced economy trends not EM ones. With private sector credit accounting for 72% of EM debt, EMs face very different challenges associated mainly with the level of NFC debt and the rate of growth in HH debt (see chart above). Note also that EM debt is also increasingly a “China-debt” story. At the end of 4Q20, China accounted for 67% and 70% of total EM and EM NFC debt respectively (see chart below).
Conclusion
Global debt dynamics are a core element of CMMP analysis. While it is natural to focus initially on the new highs in the global debt levels and debt ratios across all sectors, it is also important not to miss the important messages associated with changes in the structure, growth and affordability of global debt.
The shift in the structure of global debt from HH debt to government debt has important implications for the severity of recessions, monetary dynamics, inflation, rates and investment risks. The nature of these implications also vary depending on whether governments are currency issuers (eg, US and UK) or currency users (eg, EA governments). The risks of a return to pre-pandemic policy mixes remain in all areas, however. Finally, EMs face very different challenges largely associated with the level of NFC debt, the growth rate in HH debt and the increasing dominance of China in EM debt.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.