Debt dynamics have become increasingly important to financial markets and economic growth over the past 10 years, largely due to the increased debt load globally. There are many reasons for optimism regarding the reflation of global growth, but the historically large debt load for both households and governments remain a major headwind, regardless of whether you think there is capacity for significantly higher debt creation or not.
One of the best illustrations I have seen of that major debt overhang is courtesy of Barry Ritholtz, who posted this chart comparison from Real Time Economics:
The outstanding debt stock, from both a private and a public perspective, has become much larger in the past 10 years, especially in the developed world, and especially in Europe. In fact, this chart is likely the best illustration of why monetary easing has not led to more economic growth, despite the rise in asset prices.
My view is that large debt loads hurt growth by hindering investment and consumption capacity in an economy. Debt on its own does not change the wealth of the globe, as one person’s liability is another person’s asset. But typically, the debtor has a higher propensity to consume (and arguably, invest in new projects) than the creditor. As a result, an increasing debt load results in a lower propensity to invest and consume across the global economy.
The global debt load rose from around $80 trillion in the year 2000 to around $200 trillion in 2010, an annual growth rate of around 12% per annum. Compare that to the 4.5% growth rate of global GDP in that same period. Credit creation was an important driver of that growth, so the pullback in credit creation in the developed world in the past few years has hurt global growth, with monetary policymakers attempting to offset that de-leveraging.
This discussion highlights why deflation is a bigger risk than inflation, though. $2-$3 trillion of monetary easing is not that powerful a force in the face of hundreds of trillions of dollars of outstanding debt. Economic growth is an imperative, but ideally it would be achieved without increasing the debt load further. Unfortunately, that seems a herculean task at best given current trends.
Of course, all of these trends are part of a much longer-term story. It’s an important economic debate, but has little impact on asset prices over the next 3-6 months. However, I expect global debt dynamics to be THE driver of asset prices over the next 3-6 years. Whether we continue along the “beautiful deleveraging” described by Ray Dalio, or experience a more ugly deleveraging, debt dynamics will be the key question for all investors.