When will record global debt levels hurt investors?

When will record global debt levels hurt investors?

When will record global debt levels hurt investors?

The complexities of the record levels of global debt mean it’s virtually impossible to predict when the economy will hit the wall.

That’s the view of David Stonehouse, vice president of portfolio manager (focus fixed income) at AGF, who believes interest rates can’t go much higher before they have a serious impact. He said when compared to GDP, the debt burden is dangerously high, adding that growing debt service payments result in less freedom to invest in other areas and stimulate growth.

Stonehouse said the global debt level – about $240 trillion – has been exacerbated since the crisis by the declining interest-rate environment since 1980, a more permissive societal attitude towards debt and the general aftermath of 2008.

By laying out the figures, albeit in an admittedly oversimplified way, he warned that the US had debt-to-GDP ratio of about 3.5 to 1, with the global ratio in a similar range. Excluding unfunded liabilities, mainly social securities, Stonehouse said the numbers do not look pretty.

He said: “If you’re looking at $65 trillion of debt [in the US] and your average interest cost is 3%, then your debt grows at $2 trillion a year. Obviously, you try to service that debt so it’s not like it goes from $65 trillion to $67 trillion right away without more borrowing, but it means you need to come up with $2 trillion of payment on the interest expense to keep it at $65 trillion.”

He explained that if the GDP of the US is $20 trillion and its nominal growth rate is about 5% then it’s only growing at $1 trillion a year to service that extra $2 trillion.

He said: “So what tends to happen – and this is an oversimplification to some extent – is that over time that debt obligation tends to grow because the economy is not growing at a fast enough pace to service that debt and contain it.”

Far for being a surprise, he said that debt levels, the yield curve and the markets are being scrutinized constantly as analysts and industry experts try to determine when the cards might fall and forewarn a recession or downturn.

But Stonehouse said there is not one level of debt and that while it would be infinitely helpful for governments, central banks and investors to know when we are approaching the wall to be able to make adjustments, the system is not that precise.

He said: “There have been a lot of studies that suggest the debt levels we have right now are problematic and will come home to roost but there is not a single point that works out to be the same from one episode to another. And therein lies the challenge.”

He added: “Another way to put it is that debt levels can rise for longer than people anticipate before you get into the credit expansion period. Different factors can adjust what is going up and why.”

Sectors, he said, are in different states, often depending on how well they weathered the crisis. Those that did, like some corporations, the Canadian housing market, and governments who had to provide a backstop to deal with 2008, have been “borrowing like banshees”. Meanwhile, sectors that were hurt badly, consumer and financial, have tightened their belts.

Stonehouse said: “It’s like the ball got handed off from two bad actors of the last cycle to excessive borrowers this cycle. You can get those dynamics ebbing and flowing from one cycle to the next. That just complicates the challenges of determining when you’re about to hit a wall. Those parameters mean it’s difficult to know when you have a problem.”

He added: “A lot of folks are looking at corporate borrowing as a potential problem and as the canary in the coal mine, but it doesn’t look like it’s coming home to roost yet.”

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