John Mauldin’s book “End Game: The End of the Debt Supercycle and How it Changes Everything” and his weekly publication ‘Thoughts from the Frontline’ address the topic of debt and in particular when debt-fuelled asset price explosions seem to be to good to be true, they probably are. Debt is useful if you can pay back the borrowed money and from it are able to generate value in an economy. This ultimately raises living standards and economic growth. However throughout history debt has been misused by both the private sector and government. This area has also been studied by Ken Rogoff and Carmen Reinhart in their book “This time is different” – see previous blog posts. Historically there has been the temptation of governments and companies to keep borrowing even during a bubble. But highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid assets, seldom survive forever, particularly if leverage continued to grow unchecked. Failure to recognise the unpredictable nature of confidence especially when you are rolling over short-term debt can lead to a collapse of confidence and fewer lenders
How the debt cycle works.
Central banks manipulate interest rates and credit conditions to encourage more spending. If this spending is not controlled it may lead to inflation (most central banks target 2%) forcing the bank to tighten monetary policy – higher interest rates. This may lead to some debt being liquidated but some debt remains and is carried over to the next economic cycle. In the forthcoming cycle the same happens again and you get more unliquidated debt which is added to that of the previous cycle and so on. As the debt load increases a country’s ability to stimulate growth falls and more debt is required to produce the same amount of growth – see image below.
In 2022, global public debt – comprising general government domestic and external debt – reached a record USD 92 trillion. Developing countries owe almost 30% of the total, of which roughly 70% is attributable to China, India and Brazil. China’s current problems can be traced back to its massive post-2008 investment stimulus, a significant portion of which fueled the real-estate construction boom. After years of building housing and offices at breakneck speed, the bloated property sector – which accounts for 23% of the country’s GDP (26% counting imports) – is now yielding diminishing returns. This comes as little surprise, as China’s housing stock and infrastructure rival that of many advanced economies while its per capita income remains comparatively low.
Sources:
‘Thoughts from the Frontline’ John Maulden
This Time Is Different: Eight Centuries of Financial Folly. Ken Rogoff & Carmen Reinhart
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