The key chart
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).
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.
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%.
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.
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.
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.
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).
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.
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.
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.
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.