The idea of a global ‘debt supercycle’ is not as scary as it sounds, but three things do threaten stability if borrowing spirals out of control, Robeco’s experts advised asset owners at a recent webinar.
Global debt has reached record levels, both in absolute terms (about USDE 160 trillion) and in relation to its proportion of world GDP (225%), prompting some to fear an impending crash. However, one person’s debt is another person’s asset – such as the trillions in government and corporate debt owned by sovereign wealth funds – which means it could just as easily be called a ‘wealth supercycle’, Robeco believes.
The concept of a debt supercycle is a core theme in Robeco’s latest Expected Returns outlook for the next five years. Lukas Daalder, Chief Investment Officer of Robeco Investment Solutions, and Léon Cornelissen, Chief Economist, discussed the topic at a webinar hosted by the Sovereign Wealth Fund Institute entitled ‘What does the debt supercycle mean for asset owners?’
“We shouldn’t over-dramatize overall debt figures or ratios,” says Cornelissen. “Debt has many facets, and it’s not true that all debt is bad. Debt allows people to invest for the future; it can transform the prospects of individuals, businesses and even economies at large. And debt is also wealth; we should ask where we could have all this tremendous amount of saving that has been generated worldwide without the rise in debt somewhere else.”
‘Net debt is a more important figure to look at than gross debt’
“Not all debt is equal of course; consumer debt for external consumption is a totally different thing to debt used by businesses to invest for the future. In some economies it is difficult to raise money through equities, such as in emerging markets, so they do it through debt instead. And net debt is a more important figure to look at than the bigger gross debt numbers.”
“What’s important to stress for debt sustainability is the ability to pay the interest on it, and we are currently still in a very low interest rate environment. It’s also important to take government assets into account; if you look at Japan, it’s gross debt is 234% of GDP, but this can be lowered by 141 percentage points when you include government assets, taking the net figure below 100%.”
Cornelissen says the usefulness of debt does have its limits, however. “We shouldn’t be too relaxed; in any economy there is a limit to productive investments. If it’s easy to take on debt, one worry is will you be able to generate enough revenue to pay it back? Increasing debt is no problem when growth is high, but if growth falls, a danger arises. And we’re now in an environment of low-growth, so increasing debt may generate problems.”
“We learned with the financial crisis that too much leverage is a bad thing. The world at the moment is still experimenting to try to find optimal leverage ratios; as we saw with Lehman, the equity of financial companies can be easily wiped out with detrimental developments.”
Daalder says that idea that the ‘debt supercycle’ is about to explode is not borne out by statistics, despite the headline-grabbing figures. “There is a high level of debt, and it has indeed increased, but it has not done so shockingly. But certain parts of the debt market have developed faster than other parts, and this is more important to look at,” he told participants of the webinar.
‘These are levels that Japan reached before the bubble burst’
He says there are three potential flashpoints for debt becoming unmanageable: China, US corporate debt issuance, and global government debt levels. “China’s credit growth has been around 20% annually from 2009-2015, and private debt owed by households and corporates now stands at 210% of GDP. That sounds ominous. These are the sort of levels that were reached in Japan before the bubble burst in 1990, and in Thailand when it led to the onset of the Asian crisis in 1997. So if history is our guide, this can only go one way.”
“However, China is a centrally led system, which makes it easier for them to tackle this problem should they need to. They may not want to solve it and risk losing their track record on reaching growth targets, so it seems likely that they’ll be kicking the can down the road for a bit longer. They have been pretty good at doing this, though this isn’t a good thing in the long run.”
Borrowing by US companies is the second problem area, Daalder says. “We all know the story of US corporates tapping into the easy bond market to finance dividends and share buybacks, and that’s a negative development, because it’s adding debt to your balance sheet without it leading to any new growth. Just borrowing money just to send out as more cash to shareholders has no upside.”
“The underlying credit profile of the debt of the US corporate sector has deteriorated in recent years, so there is the risk of a negative credit cycle here. But keep in mind that the size of the sector isn’t high in international terms – it’s about 60% of GDP, which is the second-lowest ratio in the world after Germany, compared to about 190% for Ireland. Additionally, cash holdings have risen in US corporates in recent years.”
Daalder says the biggest increase of all has been in government borrowing as they deal with economic problems following the 2008 financial crisis and the large deficits that have ensued. “They’ve let government finances run loose, and the consequence has been that debt as a proportion of GDP has dramatically risen in all economies.”
“This is a problem, though there is also a ‘solution’ in that central banks have been acting as the lender of the last resort, buying up bonds, and owning more and more of this debt. This will continue to lead to very, very low interest rates, which will feed the cycle of ever-increasing debt. So it’s not a real solution and is instead another case of kicking the can down the road.”
“In all, the threat of a major credit cycle meltdown is relatively limited, but the longer this current low-rate environment continues, the bigger this problem becomes. But we haven’t reached an inflexion point yet and are likely to see this ‘let it go’ scenario for another few years yet.”