With global debt rising rapidly, many investors worry about a repeat of the 2008-2009 financial crisis, once the inevitable credit crunch hits. A recent report from leading credit rating agency Standard & Poor’s (S&P) sees increased risks, but indicates that the fears may be overblown.
“Global debt is certainly higher and riskier today than it was a decade ago, with households, corporates, and governments all ramping up indebtedness. Although another credit downturn may be inevitable, we don’t believe it will be as bad as the 2008-2009 global financial crisis.” according to Terry Chan, a credit analyst with S&P Global Ratings, as quoted by CNBC. The table below summarizes four reasons why S&P believes that the next crisis is likely to be less severe than the last one.
Four Reasons Why The Next Financial Crisis Will Be Less Severe
- Current debt surge mainly from sovereign government borrowing
- High investor confidence in hard currency debt from advanced countries
- U.S. households have been prudent, raising their debt by just 7% in 10 years
- High level of internal funding limits global risk from Chinese corporate debt
Source: S&P, as reported by CNBC
Significance For Investors
Total worldwide debt reached $178 trillion in June 2018, including borrowing by governments, corporations, and households, S&P reports. This represents a 50% increase from the figure 10 years prior, in June 2008. However, debt as a percentage of world GDP has gone from 203% to 231%, meaning that the overall leverage ratio for the world economy is up by just 15%.
Worldwide government debt was $62.4 trillion in June 2018, for a 77% increase in 10 years. The U.S. leads the way, with $19.5 trillion, up by 117%. Of the $62.4 trillion figure, $29.0 trillion is from other advanced countries, $6.2 trillion from China, and the remaining $7.6 trillion from other emerging market countries.
“Despite higher leverage, the risk of contagion is mitigated by high investor confidence in major Western government’s hard currency debt. The high ratio of domestic funding for Chinese corporate debt also reduces contagion risk, because we believe the Chinese government has the means and the motive to prevent widespread defaults,” the report observes.
Non-financial corporate debt has had explosive growth in China, up by more than five times in the past 10 years, from $4.0 trillion to $20.3 trillion. China now accounts for 29% of global non-financial corporate debt, and contributed 68% of the worldwide increase over the past decade.
An unambiguously positive development regards household debt in the U.S. and the eurozone household debt, up by just 7% and down by almost 2%, respectively, across the last decade. In China, however, household debt surged from $0.8 trillion to $6.6 trillion, up by 716% and representing 72% of the global increase.
“While we believe contagion risk is lower than in 2008-2009, risks are elevated. Due to extremely low interest rates, the past decade has seen migration of investor flows into speculative-grade and non-traditional fixed-income products. These markets tend to be less liquid and more volatile, and could seize in the event of a financial shock or panic,” S&P warns. A key driver of the 2008-2009 crisis was the meltdown of complex securities that came to be known as toxic assets.
Even if S&P is correct, and the next financial crisis is not nearly as bad as the last one, it is still likely to be a wrenching experience with widespread negative impacts on investors and the general public alike.