Rising debt levels could trigger damaging downturn for financial markets

A new report finds global debt has ballooned since the financial crisis, which makes another downturn for financial markets look inevitable.

Rising debt levels “could trigger a systemically damaging downturn”, a report from credit rating agency S&P Global has warned.

As Money Observer highlighted in our March edition, the current expansion in the US economy is the longest on record, and fears are mounting that the cycle may be turning, in part due to signs that the Trump-inspired fiscal impulse is starting to wane.

Moreover, China, whose past decade of economic growth has arguably been the principal driver of the global economy, also looks to now be on a trajectory of lower economic growth

But, according to S&P Global, increasing levels of global debt could instead be the factor that triggers the next downturn. The ratings agency points out the low interest rate environment and unconventional monetary policy in the form of quantitative easing have led total global debt to GDP to rise from 208% to 234%, from June 2008 to June 2018. On a global scale, governments, corporates and households have all increased indebtedness.  

The report adds, though, that while debt is certainly higher and riskier than a decade ago, the likelihood of a widespread investor exodus looks as though it will be contained. That is because the increased debt levels have largely been driven by advanced economies, which in turn mitigates the risk of contagion.

The report adds: “That’s not to say there is no vulnerability. A perfect storm of realized risks across geographies and asset classes could trigger a systemically damaging downturn.

“Nonetheless, we believe the next global debt crisis is unlikely to be as severe as the one in 2008-2009. The risk of contagion (a requisite for a full-blown crisis) is mitigated by high investor confidence in major Western governments’ hard currency debt.”

In addition, S&P Global notes that Chinese firms make up around 20% of debt deemed “aggressive and highly leveraged”. However, a “high ratio of domestic funding” by the Chinese government means that such debts should in theory be serviced. 

For some time Bruce Stout, manager of the Murray International investment trust, has been warning that rising debt levels look unsustainable and that at some point stockmarkets could pay the price.

In Murray International’s annual report, released last week (8 March), Stout described the investment environment as “fragile” due to the risks that rising debt levels have created.

He added: “An unfamiliar economic landscape of chronic over-indebtedness, insolvent sovereign balance sheets, extinct policy options, structured income inequalities and unpredictable disruptive industries dominate the developed world outlook.  Presumptions that the further backward you can look the further forward you can see also appear increasingly redundant against this backdrop. 

“Yet beyond the economic ambiguity of what outcomes ultimately evolve, some common constants prevail.  Business cycles come and go, interest rates go up and down and pursuit of investment returns continues regardless. 

“To this end, our investment strategy will remain disciplined, focused and geographically diversified.  Balance sheet strength and quality will be emphasised as will exposure to genuine growth opportunities.  Over and above, as market emotions invariably ebb and flow, resolute realism will be rigorously applied.”

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