‘“How did you go bankrupt?” Bill asked.
“Two ways,” Mike said. “Gradually and then suddenly.”’
The above is a snippet from Ernest Hemmingway’s 1926 novel The Sun Also Rises.
The story follows a group of expats that travel from Paris to Spain to the Festival of San Fermin to watch the running of the bulls.
Back in 2008, I was living in Spain.
The crisis that hit the country that year had a profound impact on the population. In fact, you only need to ask, everyone has a story about how the crisis has affected their finances.
Lately I have been thinking quite a bit about that time. How did we get there?
How did Spain collapse financially?
Well, as Hemmingway put it, it was gradual at first…and then suddenly, everything collapsed.
A year earlier, in 2007, things were good. Great, in fact.
There were plenty of jobs. There was a lot of money around. Restaurants and shops were buzzing. There were flash cars everywhere and everyone had the latest gadget.
Cranes filled the skyline. Property was booming.
Credit was flowing and easy to get. In fact, many Spaniards back then fulfilled their dream of owning a home.
Fast forward to a year later and things were very different.
Jobs were tougher to come by. Restaurants and shops were constantly going out of business.
Whole developments became ghost town.
Shopping centres were still full…but you barely saw people at the cash registers, or walking around with shopping bags.
When you looked up at the skyline, there were no cranes. All you saw were ‘for sale’ signs.
The fall may have been quick and sudden, but we had been building to the collapse for years.
Not many saw it coming. And even those who did greatly underestimated the severity of it.
During the build-up there was a lot of credit availability. People were taking on debt to jump into property, buy a car, furniture, a holiday home, you name it.
Spanish household debt to GDP between 2000 and 2010 almost doubled.
Property prices were growing at a much faster pace than salaries. As you can see in the graph below, new property nominal prices per square meter (yellow line) had become quite detached from inflation (green line).
The illusion of wealth
An increase in foreigners purchasing property, low interest rates and free flowing credit combined to boost property prices.
So as prices increased, people were taking on more debt to buy property. Yet there is only so much you can stretch your salary to take on debt.
When we couldn’t sustain the fantasy anymore, everything collapsed.
All the money was gone. Like in a twisted magic trick, it had disappeared suddenly.
All that was left was debt…and devalued homes.
Between 2008 and 2016 properties saw their value slashed by half. Many of those who bought their homes at the top, between 2005 and 2007 have already lost their homes.
After 2008, banks stepped up to the plate to boost the economy.
They dropped interest rates to record lows. They bought a lot of assets, which inflated asset prices.
But, all this did was defer the problem. In fact, we haven’t solved much since the 2008 crisis.
10 years on and all we have to show for ourselves is more debt.
At the end of 2017, world debt had reached a whopping US$237 trillion. Let me spell it out for you. That is 237,000,000,000,000. Yep, that many zeros.
We have been adding debt in all areas: corporate, government and household. As you can see in the graph below, we have added 70 trillion — or 42% — in debt in the last 10 years.
Are we heading towards another global financial crisis?
Much like 2008, we are gradually building our way towards a crash.
And there are warning signs…
After years of low interest rates, asset prices around the world — like property and the stock market — have ballooned. Unemployment is at low levels, yet wage growth is non-existent.
There is a lot of debt, debt that at some point will need to be paid off. It is easy to take on debt, the hard part is to repay it.
Things may seem good now, but trust me, perceptions can change quickly.
We are now facing a grim future.
In a highly indebted world — characterised by employment instability, low growth and financial insecurity — how do you protect your wealth in this scenario?
The trick is to prepare before the collapse.
How long will this gradual build-up last?
We are not sure. We could be here a long time.
But when the collapse happens, it will happen quick.
Editor, Markets & Money
PS: Financial expert Vern Gowdie explores why a credit collapse could occur in 2018, and how you can protect your assets. Click here for free action plan.