Why All This Debt is a Problem

Australian incomes haven’t really increased in almost 10 years. At least this is according to the latest Household Income and Labour Dynamics (HILDA) survey.

As HILDA reports, we saw much of the median income growth between 2001 and 2009. Expressed in December 2016 prices, the median household annual disposable income increased from $60,080 in 2001 to $79,160 in 2009.

In contrast, since then to December 2016, the median household income has barely increased to reach $79,244.

While incomes haven’t grown, household debt has been increasing. Australian household debt to Income ratio is almost 200%.

And with incomes barely growing, and costs of living rising, Australians could find it harder to repay all that debt.

The thing is, this isn’t just an Australian problem.

Income growth has been stalling in developed countries in recent years. Meanwhile long-term low interest rates have meant that we have been accumulating more debt. World debt is at record highs…and it is still increasing at alarming rates.

According to a recent study by the Institute of International Finance (IIF), courtesy of Bloomberg, since 2003, global debt has increased from US$100 trillion to a whopping US$247 trillion in the first quarter of 2018.

As you can see below, it has increased in all areas.

Since 2003, global debt has increased from US$100 trillion to a whopping US$247 trillion in the first quarter of 2018 31-07-18

Source: Bloomberg

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The non-financial sector, that is households, non-financial corporate and government make up about US$186 trillion of it.

Corporations have been borrowing to buy stock back, households have been borrowing to buy increasingly more expensive assets. Governments have been borrowing on infrastructure plans and to cover deficits. 

The thing is, we have been taking on more debt to create growth. But, there is only so much growth you can create with debt. At some point, this debt fuelled growth creates less and less growth.

As you can see below, while there is high debt, we haven’t seen much growth in advanced economies.

Markets & Money 31-07-18

Source: World Bank

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And the problem is that, if things stay the same, it will become increasingly harder to pay on that debt. We have been taking on more and more debt on the premise that we would be able to repay it with growing incomes.

But incomes aren’t growing.

And global trends could make incomes look even smaller…and debt a lot bigger.

Since 2009, interest rates have stayed low, and debt has remained cheap. Yet now interest rates are rising in many parts of the world. The US Federal Reserve and the Bank of England are starting to raise rates. The European Central Bank is looking at increases next year. All that debt is going to get more expensive.

And the thing is, costs are rising.

For one, there is the increasing oil prices. Oil prices have been rising on concerns of supply constraints. Venezuela has been decreasing oil production and Iran is looking at sanction from the US. Higher oil prices will mean higher prices.

And, of course there is the trade war. Tariffs will make things more expensive and it could slow economic growth.

The thing is, with such high debt and increasing concerns, we could see credit tightening. This would make refinancing and more borrowing even harder, which could impact growth.

As the IIF Executive Managing Director Hung Tran said in the data release:

Non-financial borrowers in the corporate sector, in the household sector, in the government sector having very high debt levels, will find it very costly and difficult to refinance and borrow more in order to sustain investment and consumption going forward. That is really causing growth to falter, so what I term headwinds to growth.

And, we are also working against demographics. Population is ageing in developed countries. Baby boomers are starting to retire, which will mean slowing production and even more liabilities for governments.

The recovery since 2008 has been weak. Back then we got in trouble because of too much debt…and things haven’t changed much. In fact, you could argue they have gotten worse.

Incomes are barely growing, debt is rising and costs of living are mounting. It will become increasingly difficult to pay off all that debt.

Risks are mounting. We are in the middle of a trade war, interest rates are rising, US has a high budget deficit, Italy and Japan have high government debt…

Trouble could start anywhere.

At some point, we will need to start paying off that debt. But, without rising incomes and with higher expenses this could prove hard to do. And we could see a real slow down.

Best,

Selva Freigedo,
Editor, Markets & Money


Selva Freigedo is an analyst with a background in financial economics. Born and raised in Argentina, she has also lived in Brazil, the US and Spain. She has seen economic troubles firsthand, from economic booms to collapses and the ravaging effects of hyperinflation, high unemployment, deposit freezes and debt default. Selva now writes from her vantage point here in Australia. She is lead Editor at the daily e-letter Markets & Money. And every week, she goes through each report and research note produced by our global network of trusted advisors to find the best investment opportunities for you in Australia and overseas. She packages these opportunities for you in Global Investor.


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