As the Global Debt Is at A High Level
Investors Become the Key Decision Makers
Since the financial crisis of 2008, the effects on global economies, the behavior of societies and the performance of markets have become puzzling. The reasons are many however there is one key factor that make the difference. This is the rise of global debt. Stocks, bonds, commodities, Forex and so on, are and will be affected for a long time by the high level of government, corporate and private debt. On a global scale and in different regions, the level of debts remains high.
Public debt in developed countries increased significantly as policy makers to address the financial crisis of 2008 and in order to avoid situations such as the Great Depression in the last century (1929), chose to introduce quantitative easing programs.
GDP Is Growing but At A Much Lower Rate
Consequently, the growing global uncertainty caused by the financial crisis and rising debt has not allowed global GDP to increase significantly in the last decade, especially in developed countries. Indeed, as shown in the charts below, according to OECD data for most of the world's largest economies, GDP growth has been slower in the last decade than in previous decades.
DEBT to GDP Ratio at Unprecedented Levels
The combination of high public debt and weak GDP growth, especially at the beginning and middle of the decade led to a significant increase in DEBT to GDP ratio and ultimately caused the debt crisis, especially in Europe. According to BIS data, in most of the developed economies, the government debt-to-GDP ratio at market prices has risen to unprecedented levels as you can see in the following charts. Over the same period, in developing countries, corporate debt to GDP has hit record highs.
Financial Repression the Methodology to Reduce Debt
When debt reaches high levels, its reduction is a subject that receives extensive attention from policymakers, who are trying to find the appropriate methods to reduce it. The methodology chosen by policy makers to reduce public debt is vital because it affects the entire spectrum of the economy, market performance, business and public life behavior. However, for most people debt is an abstract concept. Even business professionals prefer to ignore its existence. But, participation in debt reduction is not optional; it is mandatory for every entity in the economic activity. Since 2008, policymakers in different countries have implemented various methods of reducing debt. Although it seems to use different ways to achieve this target, at the end of the day, they all have implemented or intend to implement a well-hidden methodology called Financial Repression.
Financial repression is a method based on a combination of low interest rates and somewhat higher inflation rates that results in a negative real interest rate, making debt more manageable while positive GDP growth evaporates debt in the long run. By creating negative real interest rates, the method of financial repression is defined as an indirect form of taxation, since it actually transfers wealth from creditors to borrowers, that is, in the case of government debt, from depositors and bondholders to governments. Thus, governments are gradually restructuring national debt using an indirect form that is difficult to be understood from the majority of the population, even from market participants. Financial Repression methodology takes different forms in each of the economies being implemented. In each of these forms it imposes government control over the regulations, creating a series of "fences", thus making it very difficult for an entity to escape. In the following chart you can see how financial repression is structured.
Central Bank Rates Will Remain Low
Policy makers with the use of the financial repression method have cut interest rates to zero or almost to zero. In early 2009, the major central banks had cut interest rates rapidly as shown in the charts below. Since then, most of them have kept interest rates low and as the financial repression method requires low interest rates, central banks will continue to keep them low for years to come, even in the coming decades.
Bond Market Offer Negatively Yields
Significant interest rate cuts by major central banks have led government bond yields to historically low levels. As a result, government bond interest rates in developed economies are at their lowest level for the past 30 years, while real interest rates are in many cases negative, as you can see in the charts below.
Why Stock Markets recovered and Remain Strong
Due to low yields on government bonds and negative real interest rates, investors have been massively shifted from deposit accounts, money markets and bond markets to equity markets. Although this is not the only reason for the rise or the stability in stock markets, for many of the developed economies, low yields, on deposit accounts, money markets and bond markets, have either fuelled the stock market indices, either minimize market turbulence or they continue to hold them steady until today.
Stock markets rebounded, as the price of main stock markets are above or well above 2008 levels, while in other cases at least remain stable as shown in the charts below.
Commodity Prices Are Difficult to Recover
The significant decline and maintenance of low interest rates for a long time in developed economies and the uncertainty caused by the debt crisis have had a significant impact on commodity prices as well as on the currency exchange rates, especially for the emerging economies. In fact, the recent debt crisis and weak growth of global GDP, have put and continues to put pressure on commodity prices.
Most commodities, after a significant decline in the 2008-2009 period, and despite their recovery in the years 2010-2012, are now moving either close to the price they were 10 years ago or below that level.
Currencies Depreciated Significantly
The crucial point is that, as most developing countries direct their investments to commodity-related productive investments, commodity price pressures have negatively affected developing countries' businesses and GDP, their creditworthiness, and hence their currencies that have depreciated significantly. For most of the developing economies their currencies depreciated against the dollar from -30% to -95% as shown in the chart below.
Total Debt Raised Significant in Developing Countries
In developing countries, the characteristics of rising debt are different from those in developed countries. As shown in charts above, Public Debt/GDP remained relatively low, however Corporate Debt/GDP has almost doubled since 2008. What is worth noting is that, due to the significant increase in corporate debt, the total debt to GDP of developing countries approaching the levels of total debt to GDP of developed countries over the past 10 years, while the total debt to GDP ratio in developed economies, it has increased relatively modest over the same period.
Per Capita Income Remains Low for the Developing Countries
The significant increase in the total debt of developing countries to the levels of developed countries raises many concerns. The most important issue is that the increase in debt to GDP is not in line with a corresponding increase in the level of per capita income as it should be. The crucial point is that the level of per capita income is considered perhaps the most critical factor as it shows the debt repayment capacity. Thus, while total debt to GDP of developing countries is approximately at the level of developed countries, the per capita income of developing countries is significantly lower than that of developed countries.
As the overall debt to GDP has increased substantially and per capita income remains low in developing countries, the risk of default for these countries in a global economic instability will be much higher than in developed countries. In addition, the sharp rise in corporate debt in many emerging market countries over the last decade is jeopardizing financial stability for these countries.
Debt Is Denominated in Foreign Currency
The challenges in developing countries are many and include, inter alia, interest rates, exchange rate risk and structural issues. An important issue concerns the fact that tens of thousands of companies from developing countries have increased their corporate debt by borrowing in foreign currency. However, when debt is denominated in foreign currency, the options for dealing with fluctuations in interest rates and exchange rates are much more difficult and the negative effects of periods of economic instability are more painful for a country's business, business and economic activity.
In addition, world trade remains relatively moderate due to the growing uncertainty associated with trade protectionism. Trade tensions between the United States and other major economic countries such as China as well as between the United Kingdom and the EU in the Brexit negotiations are likely to reduce business productivity and profitability. Trade protectionism has already begun to negatively affect confidence, and a further escalation would hurt economic recovery, as trade protectionism is a factor that could adversely affect confidence, business and jobs.
The global financial crisis has led to more regulations, stricter prudential rules, higher capital requirements, and has also helped to improve the overall quality of loans, making the banking system safer, thus enhancing the ability of banks to withstand financial hardship. But as the market seeking more freedom in the same period it found indirect ways of financing. Thus, credit supply expanded into a shadow banking system of unregulated non-bank financial intermediaries. As the ability of non-bank financial intermediaries, to absorb a downturn in the economy is untested, a possible downturn in the coming years, can result in widespread defaults to non-bank financial intermediaries and lead to tremendous financial instability.
The Rise of Populism
The situation has become more complicated in the last decade, as policies adopted by policymakers in the last decade have put considerable pressure on society. The quality of life has deteriorated for most people, due to global financial uncertainty, low GDP growth, high level of debt, worse paid jobs, increased social security contributions, zero return on deposit accounts and so on. Consequently, all this has resulted in the rise of populism, nationalism and polarity. Phenomena that have re-emerged after nearly a century at the global level. In fact, nationalist and populist parties have already established themselves in many developed countries, where many of these parties and their leaders, despite their extreme ideas and behaviour, are either in the limelight influencing political decisions or have already taken political power.
Now is the time that the responsible policymakers should aim at structural reforms to make the global economy resistant to possible turbulences and, therefore, increase confidence in the markets and in society. However, structural reforms demand strong leaders and global cooperation. With the rise of populism, it seems that neither of the two demands can be achieved.
The Global Challenges
Global economy, markets, societies and countries seem that have already moved into uncharted waters and most probably will remain there for a long time. Therefore, today it is more than ever necessary to understand deeply the key global issues so that we can understand market movements in the best possible way. The last decade only revealed the tip of the iceberg. Under the surface, there are more critical and complex challenges that will affect business activities, economies and markets at a global level, which are concerning:
(i) the effects of the Fourth Industrial Revolution, as it constitutes one of the greatest challenges in the history of mankind,
(ii) the main issue of Environmental Sustainability, where the climate crisis not only undermines human health but also causes the existing geography of the earth, even the existence of humanity,
(iii) the significant turbulence in Socioeconomics, with the increased inequality, the rise of nationalism and the disturbance of the labour market,
(iv) the New Model of Productivity with the great importance of new technologies and the need to create high quality human capital,
(v) the major changes to Business Development that focused on collaboration, new rules, regulatory structures and after-sales service,
(vi) the crucial issues of Managing Ethics as it arises a new era, that appear, "Trans-Humans", unclear enemies, propaganda, fuzzy weapons,
(vii) the New Global Geopolitical Map as the world is characterized by multipolarity with new global forces that have different perceptions of the prevailing global values.
Risk / Investment Managers Become the Global Decision Makers
Historically, three are the main policy makers whose decisions affect the economy, businesses and markets. These are, the governments, the central banks and the Risk/Investment Managers. Depending on the time and circumstances, each one of them takes the lead to solve problems and pave the road to prosperity.
Central banks took the lead at the beginning of the global financial crisis. They cut interest rates and gave the market liquidity, preventing a major global recession. At the same time, governments with structural reforms and tax cuts have sought to normalize and boost the economy. After ten years of continuous efforts, both seem to have neither the tools nor the power needed to lead to global recovery and prosperity.
From now on, and probably in the coming decades, Risk and Investment Managers will become the main decision makers, as they will have the greatest responsibility to address the aforementioned issues and the global challenges outlined above. By introducing the right strategies will benefit from these challenges, leading to global recovery and prosperity.
In the light of all of this, from this column on FXStreet, it will be analysed in the coming months, each of the challenges and issues discussed above, by guiding investors to understanding clearly, the facts and data affecting the economy and the financial markets by taking advantage on them.