With a growing number of countries looking to, or having already used some sort of policy maneuver to bail themselves out and increase their national debt. How do we know when we’ve reached a limit on the debt we can handle? Or are the Keynesian right and can we just keep spending?
In a recent letter to investors (available here) Kyle Bass of Hayman Capital, calls the current economic climate, “a conclusion to the global debt super cycle.”
His thesis is simple; the world is “saddled with too much debt”.
He explains that since 2002, “total global credit market debt has grown at more than an 11% compound annual growth rate (“CAGR”) from $80 trillion to approximately $200 trillion. Over the same time, global real GDP has only grown at approximately a 4% CAGR”
He finds that right now, total credit market debt is 310% of GDP. This means that we are “saddled” with the largest accumulation of peacetime debts without much of an idea of what to do next according to Bass. If you look back at history, whenever total credit market debt breached 200% of GDP, it was usually due to deficit spending fueled by borrowing as nations prepared for and then fought wars. To the victor went the spoils (and debt pay-downs) and the loser got their cities turned to rubble and a crappy credit score (they defaulted on their debt). Given the enormity of the debt burdens of the PIIGSBF (Portugal, Italy, Ireland, Iceland Greece, Spain, Belgium and France) coupled with those of Japan (and at some point the US), lending schemes designed to lend more into an intractable debt problem according to Bass “are destined to fail miserably.” Bass eventually goes onto state “There is no savior large enough with a magical pool of capital to stave off this unfortunate conclusion to the global debt super cycle. We think hard defaults are imminent.”
Bass’s argument, that eventually no one will be able to pay off their debt is certainly alarming. But in an economic environment where borrowing rates are near zero, theoretically couldn’t the debt be carried indefinitely? If we continue holding rates low, which seems to be the plan of the central banks, then the problem is not the size of the debt but the interest service it carries. Where the true obligation lies is with what is payable to the private sector and outside sovereigns debt holders. What is worrying then is for countries with large debts, a slight change in borrowing rates could cause their ability to meet debt obligations to private sector and sovereign holders (private markets), to plummet.
Continuing to pile on the pressure, Gary Shilling of A. Gary Shilling & co, thinks we will see defaults in the private markets (check out this video). Shilling’s states that, “the sovereign crisis is a symptom of the underlying loss of purchasing power by global populations.” Shilling sees the world entering, a “deleveraging in the private sector.” For us simpletons this is called deflation, or for Bass, “a conclusion to the global debt super cycle.” Deflation or a super cycle ending would then dry up private markets through a loss of purchasing power. The loss of purchasing power would force the government to increase yields on its debt to attract investors. An increase in yields would cause governments to default on both private and public debts, as they struggle to meet higher debt service obligations. So in conclusion, Bass and Shilling agree, we’re already beyond help. With both public and private credit markets drying up, we don’t have many options if we keep operating under the status quo. Unless of course the debt magically disappears, but we’d need Houdini for that and he’s got his own problems.