On 9 February, President Trump signed a two-year budget deal that funds the US federal government up to 23 March and suspends the debt ceiling for one year. The agreement averts another government shutdown, which has now happened nine times since 1990. The solution has been a boost to spending that adds to the growing deficit in order to finance operations and governmental agencies.
The above is just an example of how debt is increasing. In January 2018, the Institute of International Finance (IIF) calculated that in the third quarter of 2017, the debt of households, businesses, banks and governments all over the world soared to a record total of €193.3 trillion. With this figure, the debt-to-GDP ratio is 318%. Broken down by economies, 74% of the debt corresponds to developed countries and the remaining 26% belongs to emerging economies. And in terms of sectors, the distribution is as follows: Households 18.70%; non-financial corporates 29.53%; financial sector 24.82%; and governments 26.95%.
There is a growing trend over the last few years, and the expansive monetary policies of the main central banks (that have brought interest rates down to zero or lower) has a lot to do with it. It has allowed for cheap financing, which has been exploited mainly by businesses, and investors, in the context of excess liquidity and a low default rate, have taken on these new issues, which have generally been very oversubscribed.
As for the public deficit, how can it be reduced? Let us examine some of the main options:
- Increase revenue through increased taxes and reduced spending. For example, by eliminating benefits. Governments do not like the sound of this option due to the political cost involved. Some countries may have room to manoeuvre when it comes to implementing expansive fiscal policies, as is the case in the US, but these policies mean added pressure on the debt and the sustainability of public finances.
- Reduce interest rates which reduce financial cost. Up until now, this has been the case, but it could come to an end, because it seems that several of the main central banks are currently moving in synch towards toughening monetary policies. An increase in interest rates could hinder the solvency of those more indebted governments. For example, in China, where there a high level of debt with regards to the real estate sector and shadow banking and there is a risk that it will end up affecting sovereign solvency. Or Japan, with a government debt-to-GDP ratio of 223.8% (estimated total debt is 400%). With 10-year rates below 0.10% and savers who are continuously repurchasing the maturities, Japan so far does not seem to be causing too much concern.
- Generate inflation. Central banks’ prime objective. Even if it remains low, the chance of surprise increased inflation is higher than in previous years, particularly within the context of more dynamic economic expansion that influences an acceleration in salary growth.
- Economic growth is the most desirable scenario. Without a doubt, this is the healthiest option, which allows for an increase in tax revenue and, therefore, a reduction in debt and an increase in financial sustainability. In this regard, the positive outlook of international institutions like the IMF and the OECD, or the early data from business confidence indicators, which are often at all-time highs, allows us to believe that economic growth will contribute to this necessary debt reduction.
- But if everything fails, in the event that we are unable to meet obligations, we are faced with the dreaded default, but we hope that debt is used prudently and that it does not reach this extreme.
It has taken us almost a decade to get over the last financial crisis caused by excessive leveraging. The combined action of the main central banks has played a fundamental role in restoring normality to economic activity. However, if history repeats itself, will they have enough margin to apply the same policies? Investors must be very aware of the indebtedness variable when selecting investments and demanding adequate return on each risk they assume.
At the time of writing, global public debt according to https://www.nationaldebtclocks.org/ is at $69,623,405,723,931. I suggest you visit the website and check the current figure.
Column by Josep Maria Pon of Crèdit Andorrà Financial Group Research.
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