Out Of This World Debt Levels Will Damn Future Generations

September 11, 2017

Out Of This World Debt Levels Will Damn Future Generations

  • Debt levels are the key driver of economic growth in developed countries. So keep an eye on debt.
  • The velocity of money, household debt, car loans and sales aren’t telling a good story.
  • Globally, the situation isn’t much better. However, there are a few exceptions.


In today’s article, I’ll analyze the current global debt environment.

Debt is an economic factor that is unwatched as long as things are going well but as soon at things turn south, everyone will be screaming about a debt crisis and the end of the financial world as we know it.

Given this, it’s extremely important to know what is going on, how sustainable the current debt levels are, what the impact of debt on the economy is, how to position your portfolio, and perhaps even how to take advantage of potential black swans arising from future debt instabilities.

The Velocity Of Money

Before digging into the debt piece of this puzzle, it’s important to check the velocity of money which shows how much of the available liquidity is actually used in transactions. This is measured by dividing GNP to the total supply of money.

Figure 1: Velocity of money M2 for the U.S. Source: FRED.

The extremely low velocity of money shows the available liquidity mostly remains in the banking system and doesn’t add to economic growth. This is also one of the reasons we have low inflation.

A similar situation is affecting Europe and Japan, so the problem is similar for all developed countries. This is extremely important because a relatively low amount of transactions doesn’t allow for the added liquidity from quantitative easing (QE) to create economic growth and to consequently service the huge debt burdens created. Firstly, to get the economies out of the 2009 recession, and secondly, with the hope of triggering faster economic growth.

Let’s now look at debt and what has happened in the last 10 years.

Debt Levels In All Sectors Have Swelled

In the last 20 years, total household debt in the U.S. has tripled while the real GDP has only increased 70%.

Figure 2: Household debt vs. real GDP growth. Source: FRED.

By increasing household debt, economic growth is driven by increased consumption and not by increased productivity. We all know that you can leverage yourself up to a point and that all the debt you take now is at the cost of future consumption, therefore the economic growth enjoyed in the last 20, or even 40, years thanks to increased consumption will come back eventually, especially if interest rates increase.

To see how consumption and, consequently, industrial production leads to higher GDP levels fueled by debt, one must take a look at vehicle loans which have almost doubled in the last 7 years.

Figure 3: Total motor vehicle loans in the U.S. Source: FRED.

Apart from unsustainably low interest rates, there is no other factor that allows for such a huge spike in car loans.

As soon as interest rates climb a bit, we will see a drop in car sales and an inevitable recession in the developed world which will also lead to a slowdown in emerging markets. What’s significant is that car sales are already in a negative trend, as was the case prior to the last 4 recessions.

Figure 4: Car sales drop first, then a recession comes. Source: FRED.

As a big chunk of auto loans (33%) are given to subprime borrowers with a FICO score below 550, we are practically seeing the same pattern that created the housing crisis in 2009. There is more regulation with mortgages now, but that isn’t true for the car industry  where often the motto for car manufacturers is “let’s sell a car to everyone that wants one.”

A Global Look

The situation in Europe and Japan is even worse.

I have discussed how Europe is toasted, though I find it difficult to write about what is going on in Japan because the quantitative easing there is unthinkable. As soon as I can digest the Bank of Japan’s easing policies, you can expect an article, however, that may take a while.

A look at the government debt map for Europe shows us what kind of a crisis looms there. Of the significant European countries, only Germany has a public debt to GDP ratio below 80%. All the other deficits are constantly growing. This isn’t a problem as long as the ECB keeps buying everything, but the future consequences are clear: either we are going to see a painful deleveraging period, or major inflation. Both will probably mark the end of Europe and the Euro as we know it.

Figure 5: European debt map. Source: Eurostat.

As soon as inflation comes or interest rates increase in Europe, countries like Italy, Spain, Portugal, and Croatia won’t be able to refinance their debt obligations and a European recession is inevitable. Thanks for the current European economic growth can be owed to huge quantitative easing, and nothing else.

In China, total debt, especially financial debt, is ballooning. However, we mustn’t forget that China is still growing at a 7% per year rate and still has to increase its GDP per capita 5-fold to reach developed country levels.

Figure 6: Chinese debt to GDP ratio. Source: Telegraph.

So there’s plenty of room for China to grow. Its system is independent, strictly controlled, the population is hardworking and listens to the central party commandments. Therefore, I’m much more positive about China than about other developed countries.

To show you how things should be, I’ll give you the example of India. In India, government debt has been stable in the last decade while the economy continues to grow at an amazing rate.

Figure 7: Indian Government debt as percentage of GDP. Source: Trading Economics.

It’s Possible To Grow Without Debt, But It Requires More Effort

As the Indian example shows, it’s possible to grow by keeping the debt burden stable and not putting too much pressure on future generations. Unfortunately, that isn’t what the developed countries aim for as they are chasing growth at any cost. Given the slow economic growth based only on leveraged consumption, the price future generations will have to pay will be huge and we can expect financial turmoil.

Keep reading Investiv Daily as we’re always analyzing the macro environment and discussing low risk, high reward investing strategies to take advantage of what’s going on in every environment.