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Debts, US, Eurozone, China, and economic crisis

by on 20/02/2018

As explained in the previous interchained articles,

the public debt of US but also some other leading economies in the world, are less threatening the world economy than the private debt, be it the householding or corporate debts.

The following chart shows the increasing trend of debt of non-financial entities world wide.

Source: IMF, Haver Analytics, BIS, Ned Davis Research, AMP Capital

More detailed data of the debt of the leading economies, shows that the most developed economies are also the most indebted ones. The country with the highest public debt is Japan followed by US and Eurozone, while the highest corporate debt is in China, with about 170% debt to its GDP, (2016 data), while Eurozone with about 100% and US with 70% debt as to GDP are far behind.

Total gross non-financial debt outstanding, % GDP

Source: IMF, Haver Analytics, BIS, Ned Davis Research, AMP Capital

Public debt is instrument to create money. But also the fractional reserve banking system is creating money. With multiplier of ten, in case of 10% minimum reserve requirement, the commercial banks have potential to create debt money ten times more than the original cash deposited in account in their bank. But the credit money, created by the banks can be relatively easily manipulated by central banks, while changing the regulations and requirements.

It seems the governments can cope with these public debts by printing new money, creating inflation, or if the inflation level exceeds the planned level, to balance the monetary situation by banks credit money squeeze in case of overheated economy. Such an act would decrease the commercial banks activity, or at least stop its increase as to GDP growth, as it happened anyway after 2008. The US banks balance sheets, that most of it is total credit activity of the banks, increased from 11 trillion US dollar before the crisis, to 17 trillion US dollars at 2017, that correspondence with the GDP growth.

As explained above and in the previous article,

the governments together with central banks have instruments to neutralize the public debt, by regulating the credit money, by norms imposed on the commercial banks system, namely changing Minimum Reserve Requirement, or Minimum Capital Requirement. The only exception is in case of US, its public debt is partly held as government securities by foreign governments, their economic political decision is exogene to US.

If public debt can be solved within the framework of the central bank activities, the private debt is a different matter, be it debts of corporate, non-corporate, non-financial businesses, or private households.

The corporate debts in the three leading economies range from 76% in the US to about 170% in China, where the corporate debt increased by 70% since 2007. This enormous increase in China was due to reaction of China to the economic crisis of 2008.

If to check the private household debts, in none of the big economies it exceeds 100% of the GDP. In the US it reached 100% before the 2008 crisis and since then it was reduced to 80%.

The private households debts to the financial institutions at the end of 2017 was about 15 trillion US dollars. Out of it 10 trillion US dollars are real estate mortgages, about 1 trillion US dollars students loans, credit cards, and auto loans, each. Most of these loans are for consumption and not future income generating investments. Mortgages are usually long term loans, partly supporting investments if paying for newly built dwelling, and partly to refinance previous investments, or purchasing an existing premise. Credit card loans are very short term, so even if their volume is significantly smaller than that of mortgages, their velocity is much more volatile, so its influence on economic activity is relatively large.

Consumers credit became important part of the economy, as it became substitute to relative reduction of wages. But this development brought new instability to the economy, caused by over indebtedness of the private households.

As to the businesses, their debt has not changed substantially after 2008 as percentage of GDP.

The over exposure of banks to mortgages, caused real estate price increases, that are in many places politically and socially unbearable. In many cities and places it created two kinds of people, those with house or apartment ownership and those without. Solution for this problem, needs political leadership ready to confront the Banks, not an obvious option.

As to the private households and nonfinancial corporate and non-corporate debts, they decreased their exposure to debt from 250% to 200% of the GDP. To add to it the substantial decrease in interest rates, and the result is enrichment of private households, their net worth grow to about 100 trillion dollars at 2017 from about 70 trillion dollars at its peak before the crisis of 2008, that dropped during the crisis to about 50 trillion US dollars. This net worth includes highly evaluated stock prices and real estate prices, so at times of boom the asset value is overestimated, while at time of bust it is undervalued. Still 100% nominal value growth highly exceeds the 50% GDP growth.

The monetary system is based on private savings and credit. The savers need to know, that their deposits are safe, and the banks have the know-how, how to nourish the savings to create new values. If this faith is broken, the whole existing system can collapse. Private debt, if not repaid on the big scale, threatens the whole monetary system.

The question is where is the tipping point of this accumulated debt? Hard to predict, because it is more expectations dependent, than result of real economic measures. Yet the next world economic crisis to our understanding will come from one of the big economies with sovereign monetary currency, US, China and EuroZone. These economic regions are also the most indebted compared to their GDP.

To put in focus the major threats to the world economy:

– US economy, with its external sovereign debts of 6 trillion dollars.

– the Euro zone economy with it’s internal sovereign debts of certain countries, like Italy with 133% public debt of the GDP or France with its 100% public and 130% corporate debts to the GDP.

– China with its corporate debs of 170% of the GDP.

Most of these debts are not only higher than the average, at their historical top level, but also continue to grow.

On the immediate level, low interest rates and/or high inflation damage the lenders, but improve the borrowers situation, so may postpone, or even annulate the risk of a new financial crisis. On the more long term Ievel, assets value, (publicly traded shares or real estate) collapse can cause a new financial crisis. What seems to me crusual is to follow the above mentioned three parameters, of the three major economies, to try to estimate, if they are out of control.

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