December release of the “Global Waves
of Debt: Causes and Consequences” report by the World Bank mostly slipped under the radar as people were focussed on Christmas celebrations and holidays. This is somewhat unfortunate as this report is one of those occasional, well researched pieces that reminds investors of the weak foundations of the global economic recovery of the last decade. To escape the ravages of the debt fuelled financial crisis of 2007-2009, we’ve gone on another debt bender. The World Bank is politely pointing this out and putting forward a few suggestions for governments to potentially lessen the risk of this renewed debt binge.
The report compares the current and largest debt wave to three historical examples; the Latin American debt crisis, the Asian financial crisis/tech wreck and the global financial crisis. The report details differences and similarities between the four waves, but most importantly notes that the latest debt wave is larger, faster and broader than the previous three. The report particularly points to growing debt levels in emerging markets but developed markets have also seen substantial growth in debt levels, particularly sovereign debt.
Arguably the World Bank report is too polite in two respects. First, developed economies mostly escape criticism with much of report focussed on emerging markets. This is understandable as the authors probably don’t want to do much more than nibble on the hand that feeds them. (The largest developed economies mostly pay the World Bank’s bills). Take the United States; despite very low unemployment and reasonable economic growth, deficits and sovereign debt growth are the order of the day. If now isn’t the time for sovereign deleveraging in America, there isn’t likely to be a point in the economic cycle where it would happen.
The second level of overly polite reporting is regarding China. The report does mention China’s debt growth, but more often it talks of emerging markets and developing economies (EMDEs). When it comes to emerging market debt levels, growth in debt is almost all about China. The graph below from part 1 of the report illustrates this, the solid lines are the aggregate of all emerging markets and the dashed lines are all excluding China. Once the Chinese debt binge is removed, emerging markets in aggregate have seen little change in total debt levels.
The report also tiptoes around the growing problem of debt China has supplied to emerging economies. China has been aggressive in its lending to less wealthy nations, often for projects of dubious value. When the debt servicing inevitably becomes problematic, China has in cases been using the situation to gain control over key infrastructure or resources. Where previously there would have been a debt restructure with creditors simply taking a loss, China is using debt restructurings to gain control over key aspects of a country’s economy.
The report tries to end on an optimistic note, arguing that this latest debt wave can be managed through transparency, policy frameworks, regulation/supervision and corporate governance. History points to an economic hangover being a far more likely outcome from this debt bender.
For investors, the primary takeaway is a reminder that Chinese debt growth is unprecedented. Whilst Chinese debt is mostly internal and denominated in the home currency (emerging market debt busts often involve substantial foreign currency debts), this simply shifts the likely outworking of a debt bust. Rather than looking to Argentina or Venezuela as recent precedents, China looks much more like Japan in the late 1980s. It’s not just the debt growth and “miracle” economic growth that seems similar, the cultural and demographic likenesses are uncanny. A potential Chinese bust is therefore more likely to be a multi-decade malaise rather than a rapid plunge.
However, this scenario assumes that the heavy hand of the Communist Party remains. If an economic downturn leads to widespread revolt and a change of government, then a rapid plunge is the most likely outcome. This is one key difference with Japan, Chinese citizens have an unwritten bargain with their government that their continued submission relies upon their wealth increasing. If the wealth accumulation of recent decades turns out to be a Ponzi scheme, the citizens will turn on their government and there will be a fight for control. The current demonstrations in Hong Kong might be just a prelude to the main event.
Your essays always produce great food for thought; you always have something original to say; thanks Jonathan