History rhymes – but this chart still needs refreshing
“The key chart”
Trends in Japanese, Spanish and Chinese private sector debt % GDP ratios (Source: BIS; CMMP)
The key message
I published this chart for the first time in 2017 to ask whether history was repeating itself in terms of private sector indebtedness – was China following in the footsteps of Japan and Spain?
It was also an opportunity to flag the rapid rise in household (HH) debt in China (see also, “Too much, too soon“), and to highlight the risks associated with rapid rates of growth in debt (see also, “Beyond the headlines“)
These trends and risks are understood better today (and the same chart has been reproduced many times by different people) – but the chart is in urgent need of an update. The reasons will be revealed later today when the BIS releases its 2Q22 update of global credit…
1Q22 Public and private sector debt ratios (%GDP) by country (Source: BIS; CMMP)
The key message
With global debt levels at a new, record high of $230 trillion and questions regarding debt sustainability dominating headlines, there are three key risks associated with popular investment narratives. The first is to treat the level of debt and the level of indebtedness synonymously. The second is to ignore the key structural shifts in global debt that have taken place since the GFC. The third is to dismiss the considerable differences that exist between the breakdown and level of indebtedness at the country level. The final risk is compounded by the fact that conventional macroeconomics typically ignores private sector debt while seeing public debt as a problem.
Debt versus indebtedness
While the level of total debt is at a new high, the level of indebtedness (261% GDP) is 30ppt below its 4Q20 peak (291% GDP). Similarly at the country level, the US and China collectively account for just over half of outstanding global debt but neither rank among the top-ten most indebted global economies. In contrast, Japan and France both rank among the top-five global economies in terms of their share of total debt and their level of indebtedness – yet, how often is France included in debates over debt sustainability?
Structural shifts
The first important structural shift in the post GFC period is the one away from relatively high-risk household (HH) debt towards lower-risk government debt driven largely by US and UK debt dynamics. The second is the “apparent” shift towards EM debt. In reality, this is a China-debt story rather than an EM debt story, however. EM ex-China’s share of global debt is largely unchanged since the GFC.
Country-level differences
Finally, considerable differences exist between the breakdown and levels of global debt ratios at the country level. Six of the 43 BIS reporting nations have above average private and public sector debt ratios – Japan, Singapore, France, Canada, Belgium and Portugal. A further 14 reporting nations have above average private sector debt ratios but below average public sector debt ratios – Hong Kong, Luxembourg, Sweden, Switzerland, the Netherlands, Denmark, Norway, South Korea, China, Ireland, Australian, Finland, Thailand, and New Zealand.
The key point here is that conventional macroeconomics typically ignores private debt while seeing public sector debt as a problem.
Note in this context, the emphasis that is typically placed on debt sustainability in the US, UK, and Italy despite the fact that these three nations are among the six reporting nations that exhibit above average levels of public debt but below average levels of private sector debt.
As noted previously, the US, Italy and Germany are also the only three advanced economies that have both household and corporate debt ratios below the levels that the BIS consider detrimental to future growth. A topic that I will return to in subsequent posts on private sector debt dynamics.
1Q22 Global debt dynamics – the charts that matter
Debt versus indebtedness
Trends in total debt (USD billions, LHS) and debt ratios (%GDP, RHS) since 1Q08 (Source: BIS; CMMP)
The outstanding stock of global debt hit a new, record high of $230 trillion at the end of 1Q22, according the latest BIS statistics (see chart above). The level of global indebtedness, expressed as the level of debt to GDP, has fallen from its 4Q20 peak of 291% GDP to 261% GDP, however.
Note that the level of debt and the level of indebtedness are not synonymous.
Top-ten ranking of BIS reporting nations by total debt (USD billions, LHS) and cumulative market share (%, RHS) as at end 1Q22 (Source: BIS; CMMP)
The US and China collectively account for over half of global debt but neither economy ranks among the top-ten most indebted global economies. At the end of 1Q22, the US and China accounted for 28% and 23% of the outstanding stock of global debt respectively (see chart above). In terms of indebtedness, the US and China rank only #16 and #13 globally, however (see chart below).
In contrast, Japan and France both rank among the top-five global economies in terms of their share of total debt (see chart above) and their level of indebtedness (see chart below) – yet, how often is France included in debates over debt sustainability?
Top-ten ranking of BIS reporting countries by total debt ratio (% GDP) (Source: BIS; CMMP)
Structural shifts
The first important structural shift in the post GFC period is the one away from relatively high-risk HH debt towards lower-risk government debt driven largely by US and UK debt dynamics. At the end of 1Q08, corporate (NFC), HH and government debt accounted for 38.7%, 31.5% and 29.9% of total debt respectively. At the end of 1Q21, these respective market shares were 38.7%, 24.9% and 36.5%. In other words, while the share of NFC corporate data remains unchanged there has been a clear shift away from HH to government debt.
Structural shifts in global debt (% total) since 1Q08 (Source: BIS; CMMP)
As highlighted in “Challenging flawed narratives” earlier this month, the structure of US debt is now the mirror image of its pre—GFC structure. This follows the shift away from HH debt towards government debt and the passive deleveraging of the US HH sector (see charts below repeated from previous post).
Shares of outstanding US non-financial debt by sector (Source: FED; CMMP)Trends in US HH debt ($ tr) and HH debt ratio (% GDP) (Source: FED; CMMP)
The second is the “apparent” shift towards EM debt. At the end of 1Q08, advanced economies and emerging markets accounted for 84% and 16% of outstanding global debt respectively. At the end of 1Q22, these respective shares had changed to 64% and 36% (see graph below).
Trends in advanced and emerging markets shares of total debt (% total) (Source: BIS; CMMP)
In reality, this is a China-debt story rather than an EM debt story, however. EM ex-China’s share of global debt is largely unchanged since the GFC. In contrast, China’s share of total global debt has increased from 5% at the end of 1Q08 to 23% at the end of 1Q21 (see chart below and “Global debt dynamics – V“)
Trends in China and EM ex-China market shares of total debt (% total) (Source: BIS; CMMP)
Country-level differences
Finally, considerable differences exist between the breakdown and levels of global debt ratios at the country level (see chart below). Six of the 43 BIS reporting nations have above average private and public sector debt ratios – Japan, Singapore, France, Canada, Belgium and Portugal (the top RH quadrant). A further 14 reporting nations have above average private sector debt ratios but below average public sector debt ratios – Hong Kong, Luxembourg, Sweden, Switzerland, the Netherlands, Denmark, Norway, South Korea, China, Ireland, Australian, Finland, Thailand, and New Zealand (the top LH quadrant).
The key point here is that conventional macroeconomics typically ignores private debt while seeing public sector debt as a problem.
1Q22 Public and private sector debt ratios (%GDP) by country (Source: BIS; CMMP)
Note in this context, the emphasis that is typically placed on debt sustainability in the US, UK, and Italy despite the fact that these three nations are among the six reporting nations that exhibit above average levels of public debt but below average levels of private sector debt (the bottom RH quadrant above).
As noted previously, the US, Italy and Germany are also the only three advanced economies that have both household and corporate debt ratios below the levels that the BIS consider detrimental to future growth. A topic that I will return to in subsequent posts on private sector debt dynamics.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
China data reinforces three key aspects of global debt dynamics
The key chart
The chart from 2019 – China’s HH credit growth outstripping GDP growth despite the fact that the HH debt ratio was close to the average for all BIS reporting countries (Source: BIS; CMMP)
The key message
This week’s news of weaker-than-expected economic growth in China and on-going challenges in the country’s property sector reinforces three key aspects of global debt dynamics:
Conventional macro thinking is flawed to the extent that it typically ignores the risks associated with private debt (while seeing government debt as a problem)
The “EM-debt” story has, for some time, been replaced by the “China-debt” story – strip out China and EM’s share of global debt is largely unchanged since the GFC
The level of any country’s debt needs to be considered in relation to its rate of growth (and its affordability and structure).
In an early 2019 CMMP Analysis report (“Too much, too soon?“), I concluded that:
“The risks associated with excess HH credit growth in China remain elevated and this analysis presents a relatively extreme example of the importance of considering the level of debt together with its rate of growth. History suggests that current trends in China are unsustainable. The most benign outcome is that the rate of growth in HH borrowing slows more rapidly with negative implications for consumption and aggregate demand. In short, China’s increasing HH debt burden represents a key headwind in the transition to a consumption-driven economy.”
Debt dynamics matter, a lot, but conventional approaches to understanding them need updating.
Trends in EM private sector debt ($bn) and debt ratio (% GDP) since the GFC (Source: BIS; CMMP)
The key message
In this fifth post in my “Global Debt Dynamics” series, I consider the hypothesis that the “EM-debt” story has been replaced by the “China-debt” story.
At its simplest, the EM-debt story refers to the sharp increase in the EM share of global private sector credit (PSC) and the narrowing of the gap between the aggregate PSC debt ratios for advanced (DM) and emerging (EM) economies since the global financial crisis (GFC).
The EM share of global PSC has increased sharply from 16% in 2Q08 to 38% in 2Q21. Over the same period, the gap between the PS debt ratios has narrowed from 86ppt to only 8ppt. This represents a remarkable structural shift from DM to EM economies.
Strip out China, however, and the EM share of global PSC is largely unchanged since the GFC. China has accounted for 20ppt of the 22ppt increase in market share described above and currently accounts for almost 70% of total EM PSC alone. For added perspective, China’s outstanding stock of PSC ($37tr) is c.10x and c.14x the outstanding stock in Korea and India respectively, the second and third largest EM PSC markets. Viewed from the narrow perspective of relative size and growth, there is some support for the hypothesis that the China debt story has replaced the EM debt story, or at least overtaken it.
There are two problems with this conclusion however: (1) it relies on an overly narrow view of global debt dynamics; and (2) in truth, there is no such thing as an EM debt story in the first place.
The EM universe includes a group of over 20 economies with very heterogeneous debt dynamics in terms of the level of indebtedness, the rate of excess credit growth and affordability of debt:
For most EM economies, the “potential-growth” story remains in both the NFC and HH sectors
Some of the fastest rates of excess credit growth are occuring in EM economies that already exhibit relatively high levels of indebtedness
Elevated affordability risks in a number of EM economies is of concern given the expected future direction of global rates
While the EM classification remains convenient, it is increasingly less relevant in terms of understanding the impact of debt dynamics on macro policy, investment decisions and financial stability.
Replace the EM debt story with individual EM country debt stories not just the China version.
EM debt dynamics
At its simplest, the so-called, “EM-debt” story refers to the sharp increase in EM’s share of global PSC and the rapid narrowing in the gap between the average PSC debt ratios in advanced (DM) and EM economies since the Global Financial Crisis (GFC).
Trends in private sector debt ($tr) and debt ratio (% GDP) since the GFC (Source: BIS; CMMP)
The outstanding stock of EM PSC has grown from $14tr in 2Q08 to $54tr in 2Q21, a nominal CAGR of 11.5% (see graph above). Over the same period, the outstanding stock of DM PSC has risen from $71tr to $87tr, a nominal CAGR of only 1.5%.
Breakdown of global PSC (% total) since the GFC (Source: BIS; CMMP)
The EM share of global PSC has increased sharply from 16% in 2Q08 to 38% in 2Q21, while the DM share of global debt has fallen from 84% to 62% (see chart above). As discussed in “Global Debt Dynamics –II”, this structural shift from DM to EM is one of the two key structural changes that have taken place in the global PSC market since the GFC (the other being the shift away from HH to NFC debt).
Trends in PSC debt ratios (% GDP) since the GFC (Source: BIS; CMMP)
The gap between the average DM and EM PSC debt ratio (debt % GDP) has also narrowed sharply since the GFC. At the end of 2Q08 the respective PSC debt ratios were 172% GDP and 86% GDP, a gap of 86ppt. At the end of 2Q21, the respective PSC debt ratios were 175% GDP and 167% GDP, a gap of only 8ppt (see chart above).
Trends in share of global PSC since GFC (Source: BIS; CMMP)
Strip out China, however, and the EM share of global PSC is largely unchanged since the GFC (see green line in chart above). China has accounted for 20ppt of the 22ppt increase in the increase in market share described above. As result, China’ share of EM PSC has risen from 36% to 68% over the period (and from 6% to 26% of global PSC).
China’s share of EM debt by category of debt (Source: BIS; CMMP)
China accounts for 64%, 68%, 71% and 61% of total, PSC, NFC and HH debt in EM respectively (see chart above). China’s outstanding stock of PSC ($37tr) is c.10x and c.14x the outstanding stock in Korea and India respectively, the second and third largest EM PSC markets (see chart below).
Relative size of PSC in largest EM PSC markets (Source: BIS; CMMP)
So in terms of relative growth, outstanding stock and relative size there are grounds for accepting the hypothesis that the EM story has been replaced by the China debt story. However, a key theme of CMMP analysis is that debt dynamics are not simply about the size/level of outstanding debt. There are other “chapters” to EM debt story including the levels of indebtedness, the growth rate in debt and the affordability of debt, for example.
EM HH debt ratios plotted against NFC debt ratios (Source: BIS; CMMP)
For most EM economies (as classified by the BIS) the potential “EM-growth” story remains. NFC and HH debt ratios in 16 EM economies remains below the 90% GDP and 85% GDP maximum threshold levels identified by the BIS (see chart above), for example. In contrast, elevated debt levels exist in both sectors in Hong Kong and Korea and in the NFC sector in China, Singapore and Chile.
NFC RGF plotted against NFC debt ratio (Source: BIS; CMMP)
As in DM, some of the fastest rates of excess credit growth are occurring in EM economies that already exhibit relatively high levels of indebtedness (for an explanation of the methodology, see here). In the NFC sector, for example, relatively high levels of excess credit growth have occurred in Hong Kong, Singapore, Korea, Chile and Saudi Arabia (see chart above). Similarly, relative high levels of excess HH credit growth have occurred in relatively indebted HH sectors in Korea, Hong Kong, Thailand, Malaysia and China (see graph below).
HH RGF plotted against HH debt ratio (Source: BIS; CMMP)
Elevated affordability risks in a number of EM economies is of concern given the likely future direction of global rates. Private sector debt ratios are not only high in absolute terms, but they are also above respective LT averages in Hong Kong, Turkey, China, and Brazil. Note in contrast the relatively low levels of affordability risk in CEE, Russia and India (see chart below).
Global DSR (x-axis) and deviations from LT averages (y-axis) (Source: BIS; CMMP)
Conclusion
In truth, there is no such thing as an EM debt story. The EM universe includes a group of economies with very heterogeneous debt dynamics. My financial stability heatmap summarising the debt dynamics of the 10 EM economies that account for over 90% of total EM PSC illustrated this clearly (see below).
Financial stability heatmap – top 10 EM economies (Source: CMMP)
So while the EM classification remains convenient, it is increasingly less relevant in terms of understanding the impact of debt dynamics on macro policy, investment decisions and financial stability.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Trends in HH debt ($tr) and HH debt ratios (% GDP) since GFC (Source: BIS; CMMP)
The key message
The household (HH) sector was at the epicentre of the Global Financial Crisis (GFC). Since then, three key structural shifts have changed the sector’s potential impact on macro policy, growth and financial stability:
a shift away from HH debt towards NFC debt within private sector debt
a shift away from HH debt towards government debt within total debt
a regional shift away from advanced economies towards emerging economies (EMs) driven largely, but not exclusively, by Chinese HH debt dynamics
The US ($17tr) accounts for almost a third of total HH debt. The level of US debt is almost 2x China’s HH debt and over 5x Japanese HH debt (the next two largest markets by size). The US and China collectively account for half of global HH debt. Once again, neither rank among the top ten most indebted HH economies, however.
Of the 43 BIS reporting economies, only 11 have HH debt ratios above the maximum threshold level (compared with 20 in the NFC sector). Of these 11, eight also have “above-threshold” NFC debt ratios – Switzerland, Norway, Canada, Denmark, Korea, the Netherlands, Sweden and Hong Kong.
Risks associated with excess HH debt growth in advanced economies are lower than in EM and, in contrast to NFC debt dynamics, are in economies with relatively low levels of HH indebtedness (eg, France and Germany). Growth risks also remain in Norway, Sweden, New Zealand, Canada and Switzerland among advanced economies.
Elevated affordability risks among advanced economies exist in Sweden and Norway where HH debt service ratios are not only high in absolute terms, but they are also above their respective LT averages.
Among the top ten economies that account for over 80% of total HH debt, Korea stands out due to elevated risks relating to HH indebtedness, excess HH debt growth, affordability and house price appreciation. This may explain why some Koreans feel that they are playing a real-life version of the “Squid Game”?
Household debt dynamics
Trends in HH debt ($tr) and HH debt ratios (% GDP) since GFC (Source: BIS; CMMP)
Household debt hit a new high of $55tr during 2021 (see chart above). The HH debt ratio (67% GDP) remains elevated by historic standards but is below its 4Q20 peak (71% GDP) and below the BIS’ maximum threshold level of 85% GDP. This is in contrast to the NFC sector, where global indebtedness (105% GDP) is above the sector’s maximum threshold level of 90% GDP.
Trends in the breakdown of PSC (% total) since the GFC (Source: BIS; CMMP)
There has been a shift away from HH debt since the GFC towards greater levels of corporate (NFC) debt within private sector debt (PSC) and towards government debt within total global debt. HH debt’s share of total PSC has fallen from 45% to 39% over the period (see chart above).
Trends in the breakdown of total debt (% total) since the GFC (Source: BIS; CMMP)
More significantly, HH debt’s share of total debt has fallen from 32% to 25% over the period, while the share of government debt has increased from 29% to 37% (see chart above). This second shift, driven by advance economy debt dynamics (and the US and UK especially), has important implications for financial stability (see “Global Debt Dynamics – I”).
Trends ($tr) and geographic breakdown of HH debt and EM share (% total) since GFC (Source: BIS; CMMP)
Since the GFC, there has also been a significant geographic shift away from advanced economies towards emerging markets. This shift has been driven largely, but not exclusively, by Chinese debt dynamics. The share of total HH debt accounted for by EMs has risen from 10% to 31%. China’s share of total HH debt has risen from 2% to 19%, while EM x China’s share has risen from 8% to 12%. Note that China accounts for 61% of total EM HH debt alone and that China, Korea, India and Brazil account for 82% of EM HH debt collectively.
Top 20 BIS reporting economies ranked by outstanding HH debt ($tr) (Source: BIS; CMMP)
The US ($17tr) accounts for almost a third of total HH debt alone. The outstanding stock of HH debt at the end of 2Q21 in the US was 1.7x the stock of Chinese HH debt (the second largest HH debt market) and 5.3x the stock of Japanese HH debt (the third largest HH debt market). Collectively the US and China account for more than half of global HH debt outstanding (see chart above).
Top 22 BIS reporting economies ranked by HH debt ration (% GDP) (Source: BIS; CMMP)
Once again, neither rank among the top-ten most indebted HH markets, however (see chart above). The US ranks #12 while China ranks #22. In contrast, Canada, Australia, Korea and Switzerland rank inside the top-ten rankings based on both the level of HH debt ($tr) and the level of HH indebtedness (% GDP).
HH and NFC debt ratios (% GDP) for BIS reporting economies (Source: BIS; CMMP)
Of the 43 BIS reporting economies, 11 have HH debt ratios that exceed the BIS’ maximum threshold of 85% of GDP. Of these 11, eight also have NFC debt ratios above maximum thresholds – Switzerland, Norway, Canada, Denmark, Korea, the Netherlands, Sweden and Hong Kong. The remaining three economies with above-threshold HH debt ratios but below-threshold NFC debt ratios are Australia, New Zealand and the UK (see chart above).
Excess HH debt growth (RGF) plotted against HH debt ratio for advanced economies (Source: BIS; CMMP)
The rate of “excess HH debt growth” in advanced economies (2.1%) is lower than the global (3.8%) and EM (8.7%) averages (click here for an explanation of the underlying methodology). In contrast to NFC sector dynamics, the highest rates of excess HH debt growth among advanced economies occurred in economies with relatively low levels of HH indebtedness. As can be seen in the chart above, France (4.2%) and Germany (3.8%) have seen the highest rates of excess HH debt growth over the past three years. Their HH debt ratios are 67% GDP and 58% GDP respectively, below the advanced economy average of 77% GDP and the BIS maximum threshold level of 85% GDP.
Risks associated with excess HH debt growth are also elevated in Norway, Sweden, New Zealand, Canada and Switzerland among advanced economies. In each case, growth in HH debt is outstripping growth in nominal GDP despite high absolute and relative levels of HH indebtedness (see chart above).
HH debt service ratios and deviation from LT average (Source: BIS; CMMP)
HH affordability risks within our sample of advanced economy are elevated in Sweden and Norway. In these economies, the HH debt service ratios (DSR) are not only high in absolute terms, but they are also above their respective LT averages despite low absolute HH borrowing costs. HH DSRs are also relatively high in Canada, Australia, the Netherlands and Denmark in absolute terms. However, in each of these cases the current DSR is below the respective LT average.
(* Note HH DSR ratios are only available for selected BIS reporting economies)
Significant variations exist in the impact of HH debt dynamics on financial stability among the ten economies that collectively account for 81% of total HH debt. Key themes include:
Korea stands out among this sample in terms of elevated risks associated with HH indebtedness, the rate of excess HH credit growth and the affordability of debt (in aggregate terms*). Note also that risks are elevated in terms of the growth in house prices (see chart below). I will return to Korean debt dynamics in more detail in a subsequent post
Trends in house prices (% YoY, real terms) since GFC (Source: BIS; CMMP)
Four of the five economies with the largest levels of outstanding debt – US, China, Japan and Germany – have HH debt levels below the maximum threshold level
The US, which accounts for 31% of total HH debt, has relatively low risks in terms of HH indebtedness, the rate of excess growth in HH debt and the affordability of HH debt
China has elevated risks associated with the rate of excess HH debt growth and the affordability of debt (at the aggregate level)
Trends in composite cost of French HH borrowing for house purchase (Source: ECB; CMMP)
France has elevated risks associated with the rate of excess HH debt growth. France is also the only economy in this sample where the HH debt service ratio is above its LT average. This is despite the fact that the composite cost of HH borrowing is at an all-time low (see chart above).
The next post in this series focuses on EM debt dynamics.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Trends and breakdown of NFC debt ($tr) and trend in debt ratio (% GDP) since GFC (Source: BIS; CMMP)
The key messages
Corporate debt hit a new high in 2021 ($86tr) and increased its market share of total private sector debt (PSC) to 61%, up from 55% at the time of the GFC. The aggregate debt ratio was 105% of GDP at the end of 2Q21, 25ppt above the BIS’ maximum threshold level (albeit below its 4Q20 peak of 110%).
Since the GFC, there has been a significant structural shift away from advanced economies towards emerging economies. Chinese debt dynamics have driven this shift almost exclusively.
China and the US collectively account for 52% of total NFC debt. However, while China ranks #6 globally in terms of NFC indebtedness, the US ranks only #22.
Of the 43 BIS reporting economies, 20 have NFC debt ratios above the maximum threshold. Among advanced economies only seven have “below-threshold” NFC debt ratios – the US, Germany, Italy, Greece, the UK, New Zealand and Australia (note, however, that the last three have “above-threshold” levels of HH debt).
Some of the highest rates of excess NFC growth have occurred in economies where debt ratios are already high and above average – Switzerland, Japan, France, Sweden and Canada. Excess growth has also occurred in other relatively indebted economies – Norway, Spain and Denmark – but at slightly slower-than-average rates. Elevated NFC affordability risks exist in Sweden, France, Canada and Norway.
Among the ten economies that collectively account for almost 80% of total NFC debt, five have above-threshold levels of NFC debt – France, China, Canada, Japan and South Korea. Of these, Japan, South Korea and France have also experienced above-average rates of excess NFC debt growth. Despite low borrowing costs, NFC debt service ratios are above their LT averages in France, Japan, Canada, Germany and the US. In contrast, NFC affordability risks are relatively low in the UK and Italy. Outside this sample, risks associated with NFC indebtedness, excess rates of NFC debt growth, and affordability of NFC debt are noticeably elevated in Sweden.
Corporate sector debt dynamics
Trends and breakdown of NFC debt ($tr) and trend in debt ratio (% GDP) since GFC (Source: BIS; CMMP)
Corporate (NFC) debt hit a new record high of $86tr in 2021 (see chart above). It accounted for 61% of total private sector debt (PSC) at the end of 2Q21, up from 55% at the time of the GFC. The aggregate debt ratio of all 43 BIS reporting economies was 105% GDP at the end of 2H21, above the maximum threshold limit of 90% GDP but below the 4Q20 peak of 110% GDP.
Structural shifts in NFC debt since the GFC (Source: BIS; CMMP)
Since the GFC, there has been a significant structural shift away from advanced economies towards emerging economies (EM), driven almost exclusively by China’s NFC debt dynamics. Advanced economies still account for the largest amount of outstanding NFC debt (49tr) but their share has fallen from 79% at the time of the GFC to 56% at the end of 2Q21 (see chart above). Emerging economies’ NFC debt totalled $38tr at the end of 2H21, 44% of total NFC debt from 21% at the time of the GFC. Note that China accounts for 71% of EM NFC debt and 31% of total NFC debt alone (see chart below). Excluding China, EMs share of NFC debt is largely unchanged since the GFC.
Trends in China’ share of EM NFC debt and total NFC debt (Source: BIS; CMMP)Top 20BIS reporting economies ranked by outstanding NFC debt ($tr) (Source: BIS; CMMP)
China ($27tr) and the US ($18tr) collectively account for 52% of total NFC credit. However, while China ranks #6 in terms of NFC indebtedness, the US ranks only #22. Indeed, among the five economies that collectively account for 80% of total NFC debt – China, the US, Japan, France, and Germany – only China and France (#5) rank among the top-ten economies ranked by NFC indebtedness. Once again, debt levels and levels of indebtedness tell us very different things.
Top 20 BIS reporting economies ranked by NFC debt ratio (% GDP) (Source: BIS; CMMP)
Of the 43 BIS reporting economies, 20 have NFC debt levels that exceed the BIS’ maximum threshold. Of these 20 economies, eight also have HH debt ratios about maximum thresholds – Hong Kong, Sweden, the Netherlands, Norway, China, Denmark, Canada and South Korea. The other 12 economies with NFC debt ratios above the maximum threshold are Luxembourg, Ireland, France, China, Belgium, Singapore, Finland, Japan, Chile, Spain, Portugal and Austria.
HH and NFC debt ratios (% GDP) for BIS reporting economies (Source: BIS; CMMP)
Note that among advanced economies, there are only seven economies with NFC debt ratios below the maximum threshold – the US, Germany, Italy, Greece, the UK, New Zealand, and Australia. Of these, the final three have HH debt ratios above maximum thresholds however (see chart above).
Excess NFC growth (RGF) plotted against NFC debt ratio for advanced economies (Source: BIS; CMMP)
Some of the highest rates of excess NFC growth have occurred in economies where NFC debt ratios are already high. As can be seen in the chart above, excess NFC growth rates in Switzerland, Japan, France Sweden and Canada all exceed the average excess growth rate for advanced economies despite the relatively high NFC debt ratios in each of these economies. Excess credit growth has also occurred in other relatively indebted economies – Norway, Spain, and Denmark – but at a slower-than-average rate.
NFC debt service ratios and deviations from LT average (Source: BIS; CMMP)
Elevated affordability risks in the NFC sector exist in Sweden, France, Canada and Norway. In each of these economies, NFC debt ratios are not only high in absolute terms (above 50%) but they are also above the respective LT averages, notably in Sweden and France.
Important variations exits in relation to the impact of NFC debt dynamics on financial stability among the ten economies that account for just under 80% of total NFC debt (see heatmap above). Note that:
Five of these economies – France, China, Canada, Japan and South Korea – have NFC debt ratios that exceed the 90% GDP BIS maximum threshold
Three of these five – Japan, South Korea and France –also exhibit well-above-average rates of excess NFC credit growth
Despite relative low costs of NFC borrowing, DSRs are above their respective LT averages in France, Japan, Canada, Germany and the US
Outside this sample, risks associated with the level of NFC indebtedness, excess growth in NFC debt and the affordability of debt are noticeably elevated in Sweden, an economy ranked #16 in terms of the absolute level of NFC debt but #3 in terms of NFC indebtedness.
The next post in this series focuses on household debt dynamics
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Financial stability heatmap for economies that account for 80% of outstanding PSC (Source: CMMP)
The key message
In contrast to conventional economic theory, CMMP analysis emphasises the impact of private sector debt dynamics on macro policy, global growth, investment decisions and risks to financial stability. Attention extends beyond the absolute level of debt to include the level of indebtedness, the rate of growth in debt and the affordability of debt. Key themes from the latest BIS data release include:
The structure of global PSC has shifted towards corporate (NFC) and emerging market (EM) debt. The latter shift reflects China debt dynamics exclusively
Absolute debt levels and debt ratios tell us very different things. China and the US account for over half of outstanding PSC, but neither ranks among the top ten most indebted economies
Eight BIS reporting economies have NFC and HH debt ratios that both exceed maximum BIS threshold levels – Hong Kong, Switzerland, Norway, the Netherlands, Sweden, Denmark, Canada and South Korea
Some of the highest rates of “excess credit growth” among advanced economies have occurred in economies where debt ratios are already high – Japan, France, Switzerland, Sweden, Canada (and Norway).
Elevated affordability risks exist in Sweden, Switzerland, France, Japan, Finland and Canada among advanced economies and in Turkey, China, Brazil and South Korea among EMs
Significant variations exist in the impact of PSC dynamics on financial stability among the ten economies that account for 80% to total global PSC (see heatmap above):
In China, risks are elevated in relation to NFC indebtedness, the rate of growth in HH debt and the affordability of PSC
In contrast, risks in the US are relatively low with the exception of the affordability of NFC debt
In North America, risks are more elevated in Canada, however, due to the levels of NFC and HH indebtedness and the affordability of debt in the NFC sector
Within the larger euro area economies, France stands out due to elevated risks associated with NFC and HH indebtedness, the rate of growth of debt and affordability in both sectors
In Asia, South Korea stands out for the levels of NFC and HH indebtedness, the rate of growth in debt in both sectors and the affordability of PSC
Private sector debt dynamics
In contrast to conventional economic theory, CMMP analysis emphasises the impact of private sector debt dynamics on macro policy, global growth, investment decisions and risks to financial stability. Attention extends beyond the absolute level of debt to include the level of indebtedness, the rate of growth in debt and the affordability of debt.
The level and structure of global PSC
Trend and breakdown of PSC ($tr) and trend in debt ratio (% GDP) since GFC (Source: BIS; CMMP)
Global PSC hit a new record high of $141tr in 2021 (see chart above). NFC debt of $86tr accounted for 61% of total PSC, up from 55% at the time of the GFC, while household (HH) debt of $55tr accounted for 39% of total PSC, down from 45% at the time of the GFC.
Trend and breakdown of PSC ($tr) and trend in debt ratio (% GDP) since GFC (Source: BIS; CMMP)
Advanced economies’ debt of $87tr accounted for 62% of total PSC, down from 84% at the time of the GFC. In contrast, EM debt of $54tr accounted for 38% of total PSC, up from 16% over the same period (see chart above). Note that China accounted for $37tr or 69% of total EM debt alone. As highlighted in “Global Debt Dynamics – I”, the EM debt story is increasingly a China debt story (see also the final post in this series). Excluding China, EMs’ share of total PSC has remained unchanged since the GFC.
Key theme #1: The structure of global PSC has shifted towards greater shares of NFC debt (at the borrower level) and EM debt (at the regional level). The latter shift reflects debt dynamics in China exclusively.
Top 20 BIS reporting economies ranked by level of debt ($tr) (Source: BIS; CMMP)
China ($37tr) and the US ($35tr) have the highest levels of PSC among the BIS reporting countries and account for 51% of total PSC collectively (see chart above). Neither economy ranks among the top ten most indebted economies, however. China is ranked #11 and the US is ranked #21 (see chart below).
Top 21 BIS reporting economies ranked by debt ratio (%GDP) (Source: BIS; CMMP)
Of the five economies that have the highest levels of outstanding PSC, only France is included in the top ten most indebted economies (see chart above).
Key theme #2: Debt levels and debt ratios tell us very different things – something that popular/populist US debt narratives often overlook (see “Houston, do we have a problem?”).
PSC and financial stability risks
In assessing risks to global financial stability, CMMP analysis extends beyond the level of debt to include the level of indebtedness (a stock-flow perspective), the rate of growth in debt, and the affordability of debt (a flow-flow perspective).
Private sector debt ratios
The chart below plots the 43 BIS reporting nations according their NFC debt ratios (x-axis) and HH debt ratios (y-axis). The two red lines indicated the maximum threshold levels identified by the BIS of 90% GDP for NFC debt and 85% for HH debt. The BIS considers debt above these levels to be a drag on future growth.
HH and NFC debt ratios (% GDP) for all 43 BIS reporting economies (Source: BIS; CMMP)
Key theme #3: Of the 43 BIS reporting nations, eight have NFC and HH debt ratios that both exceed the maximum BIS threshold levels of 90% and 85% of GDP respectively – Hong Kong, Switzerland, Norway, the Netherlands, Sweden, Denmark, Canada and South Korea.
A further twelve economies have excess NFC debt ratios and three economies have excess HH debt ratios. Note, in contrast, that the US is one of only four advanced economies to have NFC and HH debt ratios below the BIS threshold (along with Germany, Italy and Greece). Note also that the traditional distinction between advanced economies and EMs is increasing irrelevant/unhelpful, especially when analysing Asian debt dynamics (see “D…E…B…T, Part II”).
Excess PSC growth (RGF analysis)
CMMP analysis has used the simple concept of relative growth factor (RGF) analysis since the early 1990s as a first step in analysing the sustainability of debt dynamics. In short, this approach compares the rate of “excess credit growth” with the level of debt penetration in a given economy. The three-year CAGR in debt is compared with the three-year CAGR in nominal GDP to derive a relative growth factor. This is then compared with the level of debt expressed as a percentage of GDP (the debt ratio).
The concept is simple – one would expect relative high rates of “excess credit growth” in economies where the level of leverage is relatively low and vice versa. Conversely, red flags are raised when excess credit growth continues in economies that exhibit relatively high levels of leverage.
Excess PSC growth plotted against PSC debt ratio (% GDP) (Source: CMMP)
The chart above plots PSC RGFs against the PSC debt ratio as at the end of the 2Q21. The red lines represent the average levels for all advanced economies. The economies located in the top right hand quadrant have experienced above average excess credit growth despite having above average PSC debt ratios.
Key theme #4: A peculiar feature among advanced economies is the fact that some of the highest rates of “excess credit growth” have occurred in economies where PSC debt ratios are already high – Japan, France, Switzerland, Sweden, Canada (and Norway).
Affordability of debt
The BIS provides debt service ratios for the private non-financial sector on a quarterly basis. DSRs provide important information about the interactions between debt and the real economy as they measure the amount of income used for interest payments and amortisations (ie, a flow-to-flow comparison). While the BIS applies a consistent methodology to derive these ratios, they are unable to remove country-specific factors completely. For this reason, the BIS typically focuses in trends in national DSRs over time. CMMP analysis incorporates both the level of the DSR and its deviation from long-term averages.
Debt service ratios – deviations from LT average versus current level (Source: BIS; CMMP)
Key theme #5: Elevated affordability risks exist in Sweden, Switzerland, France, Japan, Finland and Canada among advanced economies and in Turkey, China, Brazil and South Korea among EMs.
In each case, the DSRs are not only relatively high in absolute terms, they are also above the 10-year average levels seen in each economy.
Financial stability heatmap
The key chart repeated – financial stability heatmap for economies that account for 80% of outstanding PSC (Source: CMMP)
Significant variations exist in the impact of private sector dynamics among the ten economies that account for 80% of global debt (see heatmap above) and also within regions (eg N America, the euro area) and between different advanced and emerging economies:
In China, risks are elevated in relation to NFC indebtedness, the rate of growth in HH debt and the affordability of PSC
In contrast, risks in the US are relatively low with the exception of the affordability of NFC debt
In North America, risks are more elevated in Canada, however, due to the levels of NFC and HH indebtedness and the affordability of NFC debt
Within the larger euro area economies, France stands out due to elevated risks associated with NFC and HH indebtedness, the rate of growth of debt and affordability in both sectors
In Asia, South Korea stands out for the levels of NFC and HH indebtedness, the rate of growth in debt in both sectors and the affordability of PSC
The next post in this series focuses on NFC debt.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Why does the changing nature of global debt matter?
The key chart
Changes in breakdown of global debt (% total) since the GFC (Source: BIS; CMMP)
The key message
“Private debt causes crises – public debt (to some extent) ends them.”
Professor Steve Keen, June 2021
While a great deal of attention is focused on the fact that global debt levels hit new highs during 2021, too little attention is given to the important changes that have taken place in the structure of global debt since the GFC.
This matters because conventional macro theory struggles to deal with the implications here, since it typically ignores private debt while seeing government debt as a problem rather than as a solution.
There has been an important shift away from household (HH) debt towards government debt at the aggregate, global level since the Global Financial Crisis (GFC). Debt dynamics in advanced economies have driven this shift, most notably in the US and the UK. In contrast, the structure of emerging economies’ (EMs) debt remains broadly unchanged, with a structural bias towards private sector debt. These trends matter for a number of reasons:
First, and in contrast conventional theory, we know that government deficits increase the supply of money (not the demand for money), crowd-in investment private spending (as opposed to crowding it out) and depress interest rates (rather than driving them up).
Second, and from this, we also know that while private sector debt typically causes crises, public sector debt typically limits their damage/ends them.
Third, the structure of US and UK debt is now the mirror image of the pre-GFC period, which reduces associated risks since governments face different financial constraints to HHs and NFCs and cannot, as currency issuers, become insolvent. Risks associated with excess credit growth exist more obviously in other advanced economies.
Fourth, EMs face very different risks to advanced economies. These are associated largely with the level of NFC debt, the growth rate in HH debt and the increasing dominance of China in EM debt.
Global debt dynamics – I
Debt dynamics since the GFC
In the “Seven lessons from the money sector in 2021”, I noted that our understanding of global debt dynamics is improved significantly by extending analysis beyond the level of debt to include its structure, growth and affordability.
In this first post of 2022, and the first in a series of five posts reviewing current global debt dynamics, I focus on the implications of the changes that have taken place in the structure of global debt since the Global Financial Crisis (GFC).
Global debt levels ($tr) and debt ratios (% GDP) as at end 2Q21 (Source: BIS; CMMP)
A great deal of attention has focused on the fact that global debt levels hit new, record highs in 2021 (see chart above). According to BIS statistics released on 6 December 2021, total debt (to the non-financial sector) reached $225tr at the end of 2Q21. NFC debt reached $86tr (38% total), government debt reached $83tr (37% total) and HH debt reached $55tr (25% total).
Note that while it is common to aggregate these three categories of debt together, it is also important to recognise that NFC and HH debt sit on the liabilities side of private sector balance sheets, while government debt sits on the assets side of private sector (and RoW) balance sheets.
Note also, that while debt levels are at record highs, debt ratios (ie, debt as a percentage of GDP) are below their 4Q20 peaks in each category.
Changes in breakdown of global debt (% total) since the GFC (Source: BIS; CMMP)
Too little attention has focused, however, on the important changes that have taken place to the structure of global debt since the GFC (see chart above). While NFC debt’s share of total debt has remained relatively stable at just under 40%, there has been an important shift away from HH debt to government debt over the period. HH debt’s share of total debt has fallen from 32% to 25% (see chart below). In contrast, government debt’s share of total debt has risen from 29% to 37%.
Trends in shares of HH and government debt (% total debt) since GFC (Source: BIS; CMMP)
Debt dynamics in advanced economies have driven this shift, most notably in the US and the UK (see chart below). In advanced economies, the US and the UK the share of HH debt has fallen from 34% to 26%, from 42% to 28% and from 43% to 30% respectively. In contrast, the respective shares of government debt to total debt have risen from 29% to 42%, from 26% to 44% and from 20% to 45% respectively. Similar shifts have also taken place in the EA, albeit in a much more muted fashion. This reflects a much lower (27%) share of HH debt at the time of the GFC in the EA.
Changes in structure of global debt by region (Source: BIS; CMMP)
The structure of EM debt remains broadly unchanged, however, with a bias towards private sector debt. At the end of 2Q21, the shares of HH, NFC and government debt to total debt in EM were 22%, 50% and 28% respectively.
Trends in structure (% total) of EM debt since GFC (Source: BIS; CMMP)
Note that China’s share of total EM debt has risen from 31% to 64% over the period. In other words, the EM debt story is increasingly a “China debt” story. For reference, China’s share of total global debt has also increased from 5% to 21% over the same period (see chart below). In contrast, EM excluding China’s share of total global debt has remain unchanged.
Trends in EM share of global debt since GFC (Source: BIS; CMMP)
Why does this matter?
This matters for a number of reasons. First, and in contrast conventional theory, we know that government deficits increase the supply of money (not the demand for money), crowd-in investment private spending (as opposed to crowding it out) and depress interest rates (rather than driving them up).
Professor Steve Keen has written extensively on this subject. He notes that, “rather than deficits meaning that the government has to take money away from the private sector – which is what the mainstream thinks the government does when it sells bonds to cover the deficit – the deficit creates money by increasing the bank deposits of the private sector”. In simple terms, by not studying the accounting involved in government deficits, Keen argues that they (mainstream economists) have wrongly classified them as increasing the demand for money, when in fact they increase the supply of money. I agree.
The implication here is that many arguments regarding global debt are in fact, back-to-front. Government deficits crowd in private spending and investment by increasing the supply of money. They also typically drive down interest rates rather than driving them up.
Second, and from this, we also know that while private sector debt typically causes crises, public sector debt typically limits their damage/ends them. Consider the EA’s fiscal rules that put limits on government debt and deficits but completely ignored private debt and credit and the history of Spanish debt dynamics after the introduction of the euro (see chart below).
Ignore excess private sector debt growth at your peril I – Spain (Source: BIS; CMMP)
After the introduction of the euro, government debt in Spain fell from 70% to 36% in March 2008. In contrast, private sector debt rose from 80% of GDP to 208% of GDP over the same period before peaking at 227% in 2Q10 at the height of the Spanish banking crisis (see chart above). Similar trends were also seen in other advanced economies. The chart below illustrates trends in private sector credit and government debt in the US.
Ignore excess private sector growth at your peril II – the US (Source: BIS; CMMP)
Excess growth in private sector debt up to a crisis point is followed by increases in government debt post-crisis in response to the collapse in demand as credit growth turns negative and the private sector reduces leverage. In short, recent history supports Professor Keen’s hypothesis that private debt causes crisis, while public debt ends them (or limits their damage). This topic and these case studies are developed in more detail in other posts/CMMP research.
Shift from US and UK HH debt to government debt (% total debt) since GFC (Source: BIS; CMMP)
Third, the structure of US and UK debt is now the mirror image of the pre-GFC period (see chart above). This reduces associated risks since governments face different financial constraints to HHs and NFCs and cannot, as currency issuers, become insolvent.
Rates of excess credit growth in EM (Source: CMMP)
Fourth, EMs face very different risks to advanced economies. These are associated largely with the level of NFC debt, the growth rate in HH debt (see chart above) and the increasing dominance of China in EM debt – subjects that I will address in the final post in this series.
Conclusion
Global debt dynamics are a core element of CMMP analysis. While it is natural to focus initially on the new highs in global debt levels, 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.
In the next post, I will examine dynamics in global private sector debt.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
What have the “messages from the money sector” taught us?
Visual summary of the CMMP framework linking all economic sectors together (Source: CMMP)
The key message
Over the past twelve months, the “messages from the money sectors” have taught us more about:
The true value in analysing global banks
How to improve our understanding of global debt dynamics
What does (and does not) constitute a pragmatic and responsible fiscal outcome
Why official forecasts for UK government spending remain flawed
How QE fuelled the “wrong type of lending” and what the ECB thinks should be done about it
How to avoid misinterpreting trends in monetary aggregates
How the behaviour of UK and euro area households reached an important inflexion point at the start of 4Q21
Unfortunately, there is a risk that the renewed rise in COVID-19 cases and emergence of the omicron variant may have masked the final lesson over the Christmas period.
Nonetheless, a final positive message from 2021 is that firmer economic foundations (and higher levels of vaccinations) suggest that both the UK and euro area regions are in a stronger position to face renewed COVID-related challenges now than they were at the start of the year.
Seven key lessons from 2021
Lesson #1: where is the true value in analysing banks?
The true value in analysing global banks comes from understanding the implications of the relationship between the money sector and the wider economy for macro policy, corporate strategy, investment decisions and asset allocations.
A quantifiable and objective framework linking all domestic economic sectors with each other and the rest of the world (see key chart above)
A deep understanding of global debt dynamics (see lesson #2 below)
Unique insights into the impact of global money, credit and business cycles on corporate strategy and asset allocation
Lesson #2: how can we improve our understanding of global debt dynamics?
Household and government debt as a share (% total) of global debt (Source: BIS; CMMP)
Our understanding of global debt dynamics is improved significantly, at the macro level, by extending analysis beyond the level of debt to include its structure, growth and affordability and, at the micro level, by distinguishing between productive (COCO-based) and non-productive sources of debt (FIRE-based), at the micro level (see lesson #5 below).
A great deal of attention focused on the fact that global debt levels hit new highs during 2021. Much less attention focused on the key structural changes that have taken place in the structure of global debt since the GFC:
There has been an important shift away from household (HH) debt towards government debt at the aggregate, global level (see chart above)
Advanced economy dynamics have driven this structural shift, especially in the US and UK
In contrast, the structure of EM debt remains broadly unchanged, with a bias towards private sector debt
I will explore the implications of these (and other structural changes) in my first post in 2022.
Lesson #3: what constitutes a pragmatic and responsible fiscal outcome?
UK financial sector balances (4Q rolling averages, £bn) (Source: ONS; CMMP)
“Pragmatic” and “responsible” fiscal outcomes are those that deliver a balanced economy not a balanced budget.
The three key sectors in any modern economy – the domestic private sector, the domestic government and the RoW – each generate income and savings flows over a given period. If a sector spends less than it earns it creates a surplus. Conversely, if it spends more than it earns it creates a deficit.
Extending fundamental accounting principles, we know that any deficit run by one or more economic sectors must equal surpluses run by other sector(s). This leads to the key identity pioneered by the late Wynne Godley:
Domestic private balance + domestic government balance + foreign balance (must) = zero
UK private and public sector net savings/borrowings as %age of GDP (Source: OBR; CMMP)
Contrary to popular political rhetoric, budget outcomes are inappropriate goals in themselves. Worse still, fiscal surpluses reduce the wealth and financial savings of the non-government sectors.
The good news during the pandemic was that the unprecedented shifts in net savings of the private sector were matched by equally unprecedented shifts in the net deficits of the public sector (see chart above for the UK experience). In other words, policy responses were both timely and appropriate. The risk looking forward is that policy makers ignore these lessons and repeat the mistakes of the post-GFC period (see also lesson #4).
Lesson #4: where are the flaws in offical UK forecasts
Historic and forecast UK sectoral net lending – % GDP, rolling annual average (Source: OBR; CMMP)
Forecast improvements in UK government finances from the OBR rely on dynamic adjustments by other economic sectors and unusual patterns of behaviour beyond that. The assumed end-result is one where sustained, twin domestic deficits are counterbalanced by significant and persistent current account deficits (see chart above).
The OBR described this as a “return to more normal levels.” CMMP analysis suggest it is anything but. Viewed from a sector balances perspective, the risks appear tilted to the downside ie, government finances may not recover as quickly as forecast.
Lesson #5: has QE fuelled the wrong type of lending?
Contribution (ppt) of COCO-based and FIRE-based lending to growth (% YoY) in total lending in the euro area (Source: ECB; CMMP)
Unorthodox monetary policy has fuelled growth in the wrong type of lending. There has been a shift away from productive COCO-based lending towards less-productive FIRE-based lending. The stock of productive lending in the euro area, for example, only returned to its previous January 2009 peak last month (November 2021).
Outstanding stock (EUR bn) of productive COCO-based lending in the euro area (Source: ECB; CMMP)
In other words, the aggregate growth in lending since then has come exclusively from non-productive FIRE-based lending. According to the latest ECB data, for example, FIRE-based lending accounted for 2.7ppt of the total 3.7% YoY growth in private sector lending in November 2021 (see chart below).
What’s driving private sector lending in the euro area? (Source: ECB; CMMP)
In its latest, “Financial Stability Review” (November 2021), the ECB calls for a policy shift away from short-term measures towards “mitigating risks from higher medium-term financial stability vulnerabilities, in particular emerging cyclical and real estate risks”.
This is a welcome development given the negative implications that the rise in FIRE-based lending has for future growth, leverage, financial stability and income inequality. Within the EA, Germany stands out given current house price and lending dynamics, the extent of RRE overvaluation and the absence of targeted macroprudential measures.
Lesson #6: how can we avoid misinterpreting monetary aggregates?
Growth in euro area M3 (% YoY) and contribution (ppt) from M1 and private sector lending (Source: ECB; CMMP)
Trends in monetary aggregates provide important insights into the interaction between the money sector and the wider economy but headline YoY growth figures can be easily misinterpreted, leading to false narratives regarding their implications.
The message from rapid broad money growth in the pre-GFC period, for example, was one of (over-) confidence and excess credit demand. In contrast, the message from rapid broad money growth during the COVID-19 pandemic was one of elevated uncertainty and subdued credit demand (see chart above). Very different drivers with very different implications…
CMMP analysis has focused on three key signals throughout 2021 to help to interpret recent trends more effectively: monthly household deposit flows (behaviour); trends in consumer credit demand (growth outlook) and the synchronisation of money and credit cycles (policy context).
Lesson #7: has HH behaviour in the UK and EA reached an inflexion point?
Monthly HH money flows as a multiple of pre-pandemic levels (Source: BoE; ECB; CMMP)
The behaviour of UK and euro area households reached a potentially important inflexion point at the start of 4Q21. Monthly money flows moderated sharply (see chart above) while monthly consumer credit flows hit new YTD highs ie, positive developments in two of the three key signals.
The recent rise in COVID-19 cases, the emergence of the omicron variant and renewed restrictions imposed by governments may result in these points being missed or, worse, still, reversed.
That said, and to finish on a positive note, firmer economic foundations (and higher levels of vaccinations) suggest that both the UK and euro area regions are in a stronger position to face renewed COVID challenges than they were at the start of the year.
Thank you for reading and very best wishes for a very happy and healthy new year.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
How the structure of global debt is changing and why this matters
The key chart
Share of government and household debt in global debt since December 2008 (Source: BIS; CMMP)
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
Trends in global debt and the global debt ratio since 2005 (Source: BIS; CMMP)
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
Share of government anf household debt in global debt since December 2008 (Source: BIS; CMMP)
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.
Trends in the share of US and UK government and household debt since 2008 (Source: BIS; CMMP)
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.
Trends in shares of EA government, HH and NFC debt since 2008 (Source: BIS; CMMP)
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).
Changes in structure of debt across EA’s largest economies (Source: BIS; CMMP)
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.
Trends in shares of EM government, HH and NFC debt since 2008 (Source: BIS; CMMP)
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).
China’s share of EM total and NFC debt since 2008 (Source: BIS; CMMP)
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.
