After years of zero interest rates, such an abrupt tightening can only cause harm.
The questions that arise are: What, when and where will it bang?
When interest rates are low, loans are cheap and financial players are enticed to borrow more aggressively. Debts are rising and with them the national debt.
The reality is that governments are the issuers of fiat money and can therefore nominally always meet their obligations by issuing more debt.
But even that has its limits: over time, they devalue the real value of the currency, and relentless budget deficits can cause inflation to boil over.
What I’m saying is that governments can put this problem off for a long time – but do you know who can’t?
You, me and more generally the entire private sector.
Because if our mortgage rates rise relative to disposable income, we won’t be able to print money to pay our debts.
If companies’ borrowing costs go through the roof and profit growth doesn’t improve dramatically, they will soon be forced to reduce their leverage or cut costs.
Therefore, it always makes sense to keep an eye on both government and private sector debt (as the chart below shows, the higher the economy’s total debt, the lower interest rates need to be for the system to stay afloat) .
Countries with high levels of private sector debt are more vulnerable to economic shocks
Countries with high and rising private sector debt are more vulnerable to macroeconomic shocks than countries with high public debt.
History proves that this is actually the case: just take a look at this great chart by Dario Perkins.
Loans to the private sector in % of GDP
- The Japanese real estate crisis in the 1990s
- The Asian Tiger Crisis at the end of the 1990s
- Spain’s real estate crisis at the beginning of the 2010s
- And now China?
All of these crises had one thing in common: private sector debt was too high and rising too quickly.
Paradoxically, the obsession with the level of national debt often leads to looking at the “wrong” countries when assessing vulnerability to crises.
Countries that keep their deficits well within limits deprive the private sector of fresh money, so that households and companies take on private debt.
Example China: Official national debt is very limited, but behind the curtain private sector debt has increased aggressively.
And when this happens too quickly and in an unproductive way, problems often arise.
Look at Canadawhich has been heavily involved in the real estate market to stimulate a domestic prosperity effect.
Today, Canada’s private sector debt-to-GDP ratio is higher than it was in Japan just before the housing market imploded there in the 1990s.
Looking instead at the United States, we find that private sector debt, excluding the financial sector, as a percentage of GDP is 20 percentage points lower today than it was in 2007.
While mainstream media commentators obsessively pounce on U.S. national debt, even though the United States enjoys the privilege of issuing the world’s reserve currency, private sector debt trends in the U.S. appear relatively benign compared to other countries in the world out of.
USA: Private sector debt (excluding financial sector)
Which countries are likely to perform worst in this regard?
Use this table to quickly identify which countries have too much private sector debt and have increased too quickly over the last 10 years.
Private sector debt as GDP
Of course, the level and rate of change of private sector debt are not the only variables that need to be considered to assess when/where/what is collapsing at the macro level.
We also need to consider other fundamentals, the type of private debt market (floating or fixed rate, short or long term), high time concentrations of refinancing, and many other variables.
So this reflection was just an appetizer for my exploration of what will break at a macro level.
The good news: I’ll be serving you the whole menu soon!
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2023-10-17 06:22:52
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