Thursday, March 26, 2015

Are the Seeds of a Depression Sprouting?


If the "markets" are rigged and economies divorced from true market valuations, then what (if anything) could trigger a recoupling of reality to the record setting flashing digits presently offered by the "market" facade?  My best guess is decelerating global credit and debt creation (and a rotation from private to government debt creation) is the harbinger progressively pushing the financial rigging to its ludicrous conclusion.  The rigging isn't likely to stop, but the loss of belief and confidence in these numbers (along with economic mismanagement based on these faulty signals) is soon to force market resets and revaluations of everything.  This will culminate in a global depression of unknown duration and depths until balance is restored.


McKinsey & Company did us quite a solid with their recent report titled "Debt and (Not Much) Deleveraging" (yes, I'm attempting to be hip...and prove to my high school age son and daughter I'm not as big a nerd as they think).  Anyway, I’d encourage economic junkies to at least read the executive summary. http://www.mckinsey.com/insights/economic_studies/debt_and_not_much_deleveraging

The report showed global debt, in total dollar terms, and global debt to GDP as a percentage continues to ramp.  Globally, debt continues growing faster than the economic activity it spurs.

But, McKenzie left an awful lot of meat on the bone (sorry, bad pun given this blogs title) and that’s what I’m serving up today…and I think it goes an awful long way in detailing the sources of the current global macro slowdown.


To put things in perspective, let’s start with global debt vs. global GDP (gross domestic product).  As shown in the below chart, debt continues growing faster than economic underlying growth (and the capability to repay or service said debt).
SOURCE: Haver Analytics; national sources; World economic outlook, IMF; BIS, McKenzie Global Institute analysis

A quick look at the four sources of the global debt in the chart below; Household, Government, Corporate, and Financial.  All are growing...some just much faster than others.
SOURCE: Haver Analytics; national sources; World economic outlook, IMF; BIS, McKenzie Global Institute analysis

But let’s compare and contrast the rate of the growth in debt, both in dollar terms and percentage terms.  The chart below shows that global debt grew 63% from '00-'07 but the rate of growth slowed to 40% over most recent 7 year period...in dollar terms the debt growth was almost identical over the two periods.
SOURCE: Haver Analytics; national sources; World economic outlook, IMF; BIS, McKenzie Global Institute analysis

The charts below are a break down from which of the four sources the growth in credit and debt came from. 
  • Government debt (below) grew in both periods but, not surprisingly, ramped up after 2008 (both in total and as a percentage).
SOURCE: Haver Analytics; national sources; World economic outlook, IMF; BIS, McKenzie Global Institute analysis

  • Corporate debt grew evenly in percentage terms over both periods (below).
SOURCE: Haver Analytics; national sources; World economic outlook, IMF; BIS, McKenzie Global Institute analysis

  • But household and financial sources pace of debt growth slowed dramatically both as a percentage and in dollar terms from the earlier to the latter periods (charts below).
SOURCE: Haver Analytics; national sources; World economic outlook, IMF; BIS, McKenzie Global Institute analysis
SOURCE: Haver Analytics; national sources; World economic outlook, IMF; BIS, McKenzie Global Institute analysis
The '00-'07 period of global growth in credit / debt was driven by near doubling of household and financial debt.  Think mortgage debt, HELOC’s, credit cards, and securitization of every sort imaginable on a foundation of growing government and corporate debt.

However, the '07 - '14 period debt creation came from significantly different and concerning sources:

  • $25 trillion in global government debt was driven by a hike of $19 trillion in advanced economy government debt.
  • $18 trillion in global corporate debt was taken on in massive bond sales and loans taking advantage of record low yields and rolling (refinancing) existing debt to ever lower rates.
  • $7 trillion in global household debt may have (net-net) been entirely due to China’s housing bubble creation of over $21 trillion in new Chinese debt…roughly half of which was attributable housing.  The US, UK / Ireland, Spain and select other recent real estate boom / bust patients saw declining mortgage debt creation and consumer deleveraging.
  • $8 trillion in global finance

Ominous warning lights and alarms should be going off about now considering 2015 and forward.  The ’07-’14 debt drivers are running out of steam and the sources of ’00-’07 debt appear to be slowing rather than revolving back to previous debt glory.  Of note:

  • China's housing driven bubble and mortgage debt binge looks to be rapidly losing steam.
  • Advanced economy consumers do not appear interested or capable of increasing their household debt further.
  • Advanced economy governments are in deep debt and running into declining rates of debt creation (US down to mere half trillion annual deficits rather than nearly $2 trillion in '09, '10…likewise slowing debt creation in most EU nations).
  • And what if corporations sense rates can go no ZIRP'ier or NIRP'ier and cut down new bond issuance or debt creation (hasn’t happened yet…but watch out if this last source of debt rolls over).
  • The rest of the world’s governments sensing softening of demand may stimulate and/or may pull in their horns...but either way it won't be enough.
Net / net, with slowing global credit and debt creation...well, things like consumer demand and commodity prices would collapse, shipping indexes tank, global economic activity start spiraling, and QE / shadow QE become commonplace but insufficient.  With slowing global credit and debt, demand would significantly fall from credit driven excess back to what can be supported by wages and savings (aka, a lot less…or in the vernacular, a depression).

If any of this sounds familiar, perhaps the long feared deflation and depression are finally overwhelming central banker and government attempts to avoid the inevitable.  Maybe, maybe not...but it sure looks like the global flow of credit and debt is decelerating...and maybe precipitously, baring all the credit induced excess capacity of nearly everything.

Or perhaps more simply put in a world where economic growth depends on ever greater credit and debt, the inevitable reality is excess capacity without the credits continued escalation…in the absence of the continued growth or flow of the credit and debt…falling demand and excess capacity creates a recession.  If the recession is repeatedly avoided by even more credit and debt…eventually the imbalance of organic demand and synthetically created supply is so great a depression is the inevitable outcome.  And the greatest fear of all is that governments, with their lapdog central banks, will attempt to fill the void and keep the game going...even if only for one more day and at an unthinkable cost.