Strong global economic growth is fuelling a credit boom; consumers are amassing excessive amounts of rising debt based on the belief that their jobs are safe. Governments are amassing huge levels of sovereign debt to drive economies and institutions are relying on credit to support growth. Overall, this is painting a bleak picture, one which is reminiscent of the 2008 financial crisis.
The 2008 Crisis
A sustained period of low interest rates was one of the major macroeconomic factors contributing to the 2008 financial crisis. Between 2001 and 2005, interest rates in the US were at significantly low levels – below 1%. As the majority of international contracts are denominated in dollars, low rates in the US had a profound effect compared to other nations.
This period of low interest rates fuelled a credit boom through a mass increase in mortgage lending, ultimately raising property prices and leading to the collapse of the housing market.
Credit-binging in the G7 Economies
The US has seen an exponential increase in its debt levels across asset classes including both corporate and sovereign debt. The standout class, however, has been student debt. This has risen by 170% since 2006, currently standing at some $1.3trn.
However, this should come as no surprise given the US has some of the highest college tuition fees across the globe. The exponential increase can be seen in the chart diagram below:
The increased reliance on credit to pay for college will mean the younger generation is left with a huge financial burden from a very young age. In the long-run, this will impact these individuals, who will find it difficult to fund home ownership and fewer people buying homes will impact economic growth.
The UK has seen ultra-low interest rates which, resulting in a surge in consumer demand for credit, leading to unsecured loans growing rapidly. A survey conducted by the FCA in the UK found that around 650,000 individuals in the UK who hold credit cards are in a constant cycle of debt, alongside an additional 750,000 consumers who are only able to make minimum repayments. The over-reliance on credit in the UK is clear, and if these figures continue to grow, it will eventually spiral out of control.
Over half of Canadians are now hovering over dangerous levels, within 200 dollars of being unable to pay their bills. Clearly, any subtle change in the economic landscape can have a damning effect on their ability to pay back any of their liabilities at all. One of the main reasons that individuals find themselves hovering over such dangerous levels is due to a lack of understanding as to how macroeconomic tools work.
For example, 60% were unaware of the effect of a change in the interest rate on their loan repayments. In the long-run, this lack of understanding leads to an endless cycle of debt accumulating; showing that over-indulgence for short-term gain was done with little thought for long-run consequences.
In Italy, debt levels have also risen to record levels, currently standing at around 132% of GDP.
In the Euro Area, Italy is one nation reaping the benefits from the ECB’s QE programme. Despite the ECB announcing on Thursday that it is ready to extend QE if needed, Italy is likely to see a surge in the cost of borrowing once this programme is brought to a close. Ultimately, this will echo the drama which unfolded with Greece and the need for a bailout.
China debt-to-GDP ratio stands at 250%. In particular, the level of private debt which has accumulated in China paints a worrying picture for the economy. China has over-relied heavily on credit to fuel investment in the country in order to achieve its significantly high economic growth targets.
In the long-run, pursuing this goal through unsustainable levels of credit is likely to result in a hard landing for the economy. More recently, in May, these worries were echoed by Moody’s who downgraded China’s sovereign debt due to fears around slowing growth and rising debt levels.
The Role of Central Banks
Central Banks have had a major role to play in the credit boom which has been seen in the global economy. Interest rates have been kept artificially low to stimulate growth. Consumers have been enticed by these low rates; for example, mortgages are being purchased at record low rates.
Given the level of household debt is so high, the central banks are hesitant to raise interest rates as doing so will hit consumers hard and may ultimately lead to another financial crisis.
However, the question remains as to how long rates can remain artificially low before they are increased to more realistic levels. This, in turn, will test the resilience of global economic growth, which has been fuelled by cheap credit.