A Black Hole of Debt

In the German language, the word for debt – ‘schuld’ – means the same thing as guilt. Someone who has a tremendous amount of guilt would seek forgiveness. So the term many economists are now using – forgiveness – in regards the world’s growing debt problem would seem appropriate. But this term does not encapsulate the crises that would result if a large portion of debt was erased by policy makers.

Until recently, the term ‘debt forgiveness’ in regards to government and corporate debt was unheard of. Yet more radical measures are being discussed as the traditional tools the Federal Reserve has used to spur the economy have failed to spur real growth.

As the economy moves through the 3rd quarter of 2016, a black hole is sucking in any small prospects of economic growth: global debt levels. In practically every category of debt, debt levels in 2016 are higher than they were in 2008. According to a study by McKinsey Global Institute last year, the grand total of government, household, corporate and bank debt jumped by 40% from 2007 to mid-2014 to $199 trillion.

Government debt levels are supposed to decrease in times of economic recovery and growth. From 2012 to 2015, U.S. growth averaged 2.4% a year compared to 3.7% a year from 2001 to 2010. This low level of growth since the Great Recession has not made a dent in government debt levels. Instead, the debt-to-GDP ratio in the U.S. increased to 233% in 2014 from 217% in 2007. Even worse, the same metric jumped from 241% to 313% in Spain and from 336% to 400% in Japan over the same time period.  Greece has failed to meet objectives after each bailout and now forgiveness of a portion or all of the debt could be possible.

Corporate and bank debt have increased as well. Corporate debt in the U.S. rose sharply from $5.66 trillion in 2005 to $8.28 trillion in 2016. Perhaps most troubling is the surge in issuance in emerging market companies. A record $1.13 trillion was issued by emerging market companies in 2014, generally with the goal of expanding production capacity. Yet, with China’s demand waning and consumer demand weak across the developed world, their investments in larger capacity have not paid off.

The most rapid debt growth has been in student loans. At relatively low level of $520 billion in 2006, student debt in 2016 has now reached $1.35 trillion. This issue has forced its way into the presidential race, with promises of faster refinancing at lower rates. If debt levels continue to rise rapidly, widespread forgiveness of student loans may be the next proposal from the candidates.

The effect of this high level of debt has been to dampen any prospects for growth. Another massive stimulus program for the U.S. economy could provide a temporary boost for certain industries, but would likely not have a long-term beneficial effect for the economy. This strategy of massive deficit spending in a recession to stimulate demand and promote recovery is a cornerstone of Keynesian economics. Yet fiscal stimulus has not led to a strong economy and the government is left with enormous liabilities in the process. Kenneth Rogoff of Harvard University, a professor who has studied the effects of debt on the economy, notes, “The problem with high debt levels is that it’s very paralyzing.”

Combined with record-low interest rates and anemic growth, the economy will continue to struggle with this cloud of debt overhead. From the start of 2016 when the yield was 2.27%, the 10-year Treasury note has sunk to the record low of 1.37%. Relative to all other developed countries, though, this yield is actually quite high. On July 8, the yield on German 10-year bunds was at negative 0.18% and, for Japanese 10-year bonds, negative 0.29%. With rates this low, the Fed will have no room to lower rates in the next recession, which have occurred every 8 years since the 1980s.

In the midst of this mountain of debt and bizarre economic conditions, the S&P 500 and Dow have reached record highs in the past weeks. The unexpected event of Britain voting to leave the EU caused a sudden decline in the market, but in the past weeks, stocks have climbed back from their losses. How long can the contradiction of record high global debt levels and the record high stock markets coexist?

We believe the status quo cannot last much longer. If debt forgiveness becomes mainstream policy or governments resort to printing money to escape debt, no paper assets will be a safe haven. Only gold and silver have historically performed well under these conditions. Call us today at 1-800-341-8584 before the coming debt crisis arrives.

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