It’s been ten years since the beginning of the global financial crisis that started in 2007. Last week marked the decade anniversary of when the largest bank in France, BNP Paribas, froze $2.2 billion worth of funds in operation citing the subprime mortgage instability in the United States. This triggered a series of events that eventually lead to the fall of investment banking company, Lehman Brothers later in 2008. The problem was the world had too much debt, particularity in the private sector. The recession was the outcome of unsustainable leverage. Massive amounts of credit was wiped out and private debt was reduced. The following chart from debtdeflation.com shows how private debt dropped as public spending rose to replace market liquidity.
But today we are seeing debt grow again. In the U.S. we are looking at some of the highest levels of private debt since the great depression, as a percentage of GDP. It dropped to as low as 196% in 2013. But last year private debt has grown again to represents 199.6% of GDP. Economic growth is likely to go negative within the next few years. This is what Japan has experienced for over twenty years. According to Reuters, Australian born economist Steve Keen warns that the US may be caught in the same situation unless something different happens. One way to stave off a depression is to generate a level of government spending that’s necessary to reduce the level of private debt. China’s private debt levels is on a rather steep incline along with a few other countries. Private-sector debt exceeds 200% of GDP in China, making it look similar to the “over-indebted economies of Ireland and Spain prior to 2008, but obviously far more significant to the global economy. “This bubble has to burst,” writes Keen unequivocally.”
Keen also mentions that the United States, England, and parts of Europe, mostly in the west, are in the post-crisis period so they’ve got a high level of debt which are either rising very slowly or actually falling. But countries like China and South Korea, and Canada, have got rising levels of private debt and more private debt than in 2008. So they’re also going to face the same slow down in debt growth and then negative growth. And when that happens they’ll have their own national financial crisis. But of course it wont be on the same scale as the U.S. due to population size. Each domestic financial crisis within a country will no doubt still affect the rest of the world though.
If the government decides to cut spending it would make the private debt situation worse because doing so would reduce income for everyone. Government can create its own money and inflate its way out of debt. That’s what we did through the second world war. The main economic impact of the second world war was drastically reducing the level of private debt. So much government money was dedicated to fighting the war, that the private sector had could afford to pay down the money they’ve borrowed for car loans and mortgages. The economy wasn’t debt constrained back then. According to Keen, “the current value of U.S. financial assets is more inflated relative to GDP than at any time in the country’s history.” This will continue to be the case as long as fiscal and monetary policy continue to support economic growth. The rise of private debt in the country and around the world is concerning. But there is not much we can do as investors except be vigilant and watch for signs of a turning point.