Global Debt Surpasses $100 Trillion: Looming Crisis or Investment Opportunity?

Introduction

Many people are likely aware that global government debt has been steadily increasing, but the growth rate has accelerated significantly since the COVID-19 pandemic began in 2020. Last month, the IMF announced that global debt exceeded $100 trillion for the first time in history as of 2023. They added that the United States and China led this increase.

Capitalism inherently requires an increase in both capital and debt. The increase in debt leveraged by capital is a natural phenomenon that accompanies economic growth. However, problems can arise when debt becomes too large relative to the size of the economy, or when debt increases too rapidly. So, is the current level of global national debt sustainable? Is there a possibility that excessive debt could lead to an economic crisis, or is this actually an investment opportunity? Let's examine these questions.

Bloomberg Outlook

The graph referenced comes from the Bloomberg article published on October 19, 2024, titled “The World's $100 Trillion Fiscal Time Bomb Keeps Ticking.”

Among the countries analyzed by Bloomberg, except for Germany, all nations are projected to see rapid increases in their debt-to-GDP ratios in coming decades. While most are developed countries except China, both China and the global aggregate debt are expected to increase rapidly. As mentioned earlier, while an increase in absolute debt levels alongside economic growth might be natural, this graph shows debt-to-GDP ratios, leaving little room for excuses.

The IMF Managing Director (Kristalina Georgieva) stated that this massive debt is burdening the global economy, and the combination of low growth and high debt points to a difficult future. She said governments need to reduce debt and prepare for upcoming crises. Her statement is surprisingly straightforward. Here's the original quote from the IMF Managing Director: "Our forecasts point to an unforgiving combination of low growth and high debt - a difficult future. Governments must work to reduce debt and rebuild buffers for the next shock - which will surely come, and maybe sooner than we expect."

This isn't just some pessimistic view from a broken clock that's right twice a day being reported by a fringe media. Bloomberg possesses the world's largest financial database and wields considerable influence in economic journalism. The IMF needs no introduction as a global institution, and they have more experience than any other institutions with national economic crises.

Is Germany Really a Model Student?

Germany stands out as the only exception among countries that Bloomberg analyzed, with its national debt-to-GDP ratio expected to decline in the coming decades. But is Germany truly a model student? Is its debt-to-GDP ratio decreasing because of an improving economy?

Unfortunately, the same Bloomberg article shows that Germany is likely to be already in a recession. While the official Q3 GDP growth figures haven't been released yet, most economists predict negative growth following Q2's contraction.

While other countries (including the US, China, and other Eurozone nations) are pursuing economic expansion policies despite fiscal deficits, Germany is not following this path.

Germany places extremely high importance on fiscal soundness. Due to the hyperinflation trauma during the Weimar Republic in the 1920s, there is a strong national preference for price stability. This is so important that they constitutionally limit the federal government's structural deficit to 0.35% of GDP.

This year's (2024) budget was actually reduced by 7 billion euros compared to the previous year. This explains why Germany's debt-to-GDP ratio is decreasing even during an economic downturn - they're maintaining tight fiscal policy.

However, critics argue that while this strict fiscal policy effectively manages debt, it also stifles economic growth and limits future prospects by holding back investment in emerging industries. So, is the solution to ramp up debt aggressively to stimulate the economy?

Net Interest Costs Relative to Government Revenues

The graph shows net interest costs relative to government revenues for major developed countries. The red bars show the actual average values for 2021-23, while the blue bars show projected averages for 2024-26.

Source: IMF, IIF; www.voronoiapp.com

The United States stands out first. Among the analyzed countries, the U.S. has the highest ratio of net interest cost to government revenue at 8.7%. This is projected to rise further to 10.9% for 2024-26. As widely reported in the media, the U.S. national debt surpassed $ 1 trillion in 2024 for the first time in history, even exceeding its defense spending. Net interest costs exceeding 10% of government revenue are not sustainable in the long term.

The PIGS nations - Portugal(P), Italy(I), Greece(G), Spain(S) - which struggled during the 2010 European economic crisis, are projected to see their already high net interest payments worsen further. Could we see a European Economic Crisis II in coming decades? Unlike 2010, the Eurozone's two core nations, Germany and France, appear to have reduced capacity to help other countries due to their own issues.

Germany's net interest payments to revenue ratio worsens from 1.2% to 1.9%, but the absolute value is small enough not to be concerning. Japan and Switzerland show slight decreases, while Denmark and Norway are expected to see their negative ratios grow larger - in other words, their revenue already exceeds interest payments and is expected to grow even more. The common factor among Germany, Japan, Switzerland, Denmark, and Norway is that they are all net creditor nations. For smaller economies like Switzerland, Denmark, and Norway, capital income from overseas appears to be significantly contributing to national revenue.

Will US National Debt Be Managed Going Forward?

On September 18th, the Federal Reserve of the United States cut the interest rates by 0.5%, citing controlled inflation and signs of rising unemployment. However, economic indicators released after the rate cut show unemployment slightly decreasing and inflation moderately increasing.

While the Fed's two official mandates are price stability and maximum employment, its more crucial role is preventing the spread of systemic risks like bank runs. An even bigger systemic risk than bank runs is the risk of national default, though the possibility of the U.S. defaulting on its dollar-denominated debt is zero. More realistically, this risk means U.S. government debt security prices could collapse due to unsustainable interest burden. While the Fed can't control the increase in national debt itself, it can manage interest costs by either significantly lowering rates or directly purchasing Treasury bonds through quantitative easing (QE) - or both. Japan has been implementing both these policies for quite a while.

Some worry about problems arising if foreign capital stops buying U.S. Treasuries, but as long as the Fed's QE option exists, the likelihood of major issues with U.S. Treasuries remains low. Of course, excessive QE could boost inflation, but in crisis situations, stabilizing Treasury rates would take priority over price stability.

It's been reported that legendary trader Stanley Druckenmiller has taken short positions on U.S. Treasuries lately (betting on rising rates and weakening bond prices). Many experts argue that the low-interest era is over, and we need to adapt to U.S. 10-year Treasury rates staying at medium levels around 4%. Most economists view the Fed's neutral rate at around 3% or even slightly higher than that. I can fully understand why Druckenmiller and economists hold this view, which I tend to agree for the short to medium term.

However, looking long-term, U.S. interest rates will ultimately have to go lower. Unless rates decrease or the government debt ratio falls, America's debt problem will worsen. Since it's easier for the government to cut rates to reduce interest costs than to reduce debt, they're more likely to move in that direction. Even if the situation becomes serious, they might make token efforts to slow debt growth, but that's about it.

Regardless of who wins the U.S. presidential election next month, U.S.-China tensions are likely to intensify. In this process, the U.S. will try to maintain its advantage over China by developing future high-tech industries centered on Artificial Intelligence, supporting the defense industry, and expanding its economy. This requires expansionary fiscal policy, so I think it's unlikely that the U.S. will follow Germany's path of emphasizing fiscal soundness, cutting budgets, and lowering debt ratios any time soon. While market shocks might temporarily push policy in that direction, I believe they'll ultimately rely on quantitative easing and low interest rates.

Closing Remarks

So, is the explosive growth in global debt, especially U.S. debt, a crisis or an opportunity? In my opinion, it's an opportunity in the short term but a crisis in the long term. Citigroup's former chairman Chuck Prince said in July 2007, “As long as the music is playing, you've got to get up and dance. We're still dancing.” The financial crisis occurred not long after that.

We're still dancing, but I think it's time to keep our ears open for when the music might stop. This is especially important because we don't know if it will be next year, the year after, or later. However, when we see investment gurus like Warren Buffett selling stocks and increasing their cash positions, we can guess that the party's end might not be too far away.

Thanks for reading. Wish you grow rich slowly and surely!

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