The world economy is heavily indebted. As Ambrose Evans-Pritchard points out, the last 15 years of central bank easing has driven total debt ratios to a record 275% of GDP in rich states and 175% of GDP in emerging markets.
At the local and individual level, where easing is not possible, any meaningful debt reduction is achieved by defaulting. As McKenzie Global Institute points out, the drop in US household debt between 2008 and 2012 is primarily explained by defaults on home loans and consumer debt (Roxburgh et al 2012).
China is at risk from debt. The central government has $4 trillion in reserves, but the country is underwater at the same time, as local provinces have taken on loans from the central government they will never pay back. The non-performing loan ratio at China’s 16 largest banks is now 5.8% and climbing.
Most developed countries meet Kenneth Rogoff’s economic impairment criteria: public debt over 90% of GDP for five years or more is associated with 1.2% lower growth. The United States would meet the criteria if the debts of its 50 states were officially included. Academics split hairs over Rogoff’s methodology, but Japan, with public debt in 2013 as 243.2% of GDP, is a living twenty-year example of the kind of impaired growth Rogoff describes.
Clearly, debt hampers growth. The larger question is whether our growth models make sense moving forward. Long-term declining world population means classic “sell 10% more this year” growth models cannot stand. With fewer people seeking housing, real estate valuations will drop, and real estate represents the bulk of global wealth.
Four primary forces have allowed the rich to increase wealth against this gloomy backdrop: a financial services industry that structures novel new debts payable by taxpayers, asset inflation by central bank easing, traditional corporations becoming pseudo-banks by extending credit to consumers, and transfers of wealth by governments to those connected to the (anti-health) medical industry.
These forces are centered around increasing the debts of the already super-indebted. And there has been short-term lift: the resulting bull market from 2009 to 2014 represents the Keynesian detachment of financial markets from the underlying goods-and-services economy. Over longer periods, this detached paper bull market will worsen the bad economy experienced by today’s average citizen, and continue the reduction of the middle class. Logically, the divorcing of Wall Street and Main Street also leads to a coming black swan event where the real economy grows while the stock market declines.
Regardless of the Keynesian detachment, a “once in 100 years” style deleveraging is likely to happen, as described by Ray Dalio. Unfortunately, the wisdom of Dalio’s beautiful deleveraging won’t happen due to lack of consensus. The deleveraging will come in the form of defaults at a local level where easing is not an option, and inflationary transfers of wealth away from savers at a central level.
Does a huge deleveraging spell doom and violence for humanity? Probably not. The real economy, measured in goods and services, is substantially capable. It seems reasonable from a pure allocation standpoint, especially with the oncoming robot economy, that every person might have shelter, food, internet access, plus some material luxuries. This becomes easy to envision as we consider that world population is projected to stay about the same, and possibly decline, after 2050.
Ultimately, the economy is about human relations, which opens every door imaginable. In one scenario that resembles today, a wholesale deleveraging never happens, and the rich keep kicking the can down the road, acting as though their annual gains and nest eggs are redeemable, all the while subsidizing real consumption by the poor, who will never pay back the ever-increasing debts making the “feel good” paper gains possible. In this win-win scenario, everybody has enough, and the rich get to go on feeling like they’re better than everyone else.