05/02/2015 - 12:41

McKinsey reveals debt risk

05/02/2015 - 12:41


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Australia’s latest political crisis, the potential dumping next week of the prime minister, Tony Abbott, is masking a far greater threat to the country – a fresh outbreak of the GFC caused by the dramatic build-up of private and public debt.

McKinsey reveals debt risk

Australia’s latest political crisis, the potential dumping next week of the prime minister, Tony Abbott, is masking a far greater threat to the country – a fresh outbreak of the GFC caused by the dramatic build-up of private and public debt.

While many people might imagine it impossible for a repeat performance of the 2008 worldwide financial meltdown just seven years later, that is precisely what might be on the way if a fresh study of debt levels in 47 countries is a guide.

McKinsey & Company, one of the world’s top management consultancies, found that global debt today is a spectacular 250 per cent, or $US143 trillion, more today than it was in 2007, the year before the crisis erupted.

Even as a percentage of the global economy, which takes into account growth in gross domestic product total debt has risen from 270 per cent to 286 per cent.

Australia, significantly, is one of the countries singled out by McKinsey as having a potentially serious problem with debt, especially the high levels being carried by households. Canada, Sweden, Malaysia and Thailand are other countries said to have ‘potential vulnerability’ to a debt crisis.

Predictions about when and how the next wave of the seemingly never-ending GFC might break are missing from the McKinsey study, which is certain to generate shockwaves – and if it doesn’t, it should.

The key to what McKinsey uncovered is what many economists have feared – that in the years after the 2008 GFC there was a massive transfer of debt from banks in the private sector to public authorities such as central banks, and private households.

In other words, governments rescuing banks as they tottered on the edge of collapse might have been doing the obvious thing at the time, but all they really did was socialise the problem by transferring the debts of the banks to taxpayers.

Today’s debt hot spot, Greece, is the place where the crisis seems likely to boil over in a showdown with the European Central Bank, which could bankrupt the country and force it to quit Europe’s common currency, the euro, and perhaps quite the European Union.

An analysis of the McKinsey study shows that what’s happening in Greece could be repeated in other countries where a debt explosion has occurred, including Australia’s major trading partner, China.

The simplest way to understand what is a complex subject – which has a lot to do with governments creating low-interest bearing debt by printing money – is to see it through two graphs.

The first (graph 1) shows how the level of worldwide private debt as a proportion of gross domestic product has declined marginally from 158 per cent to 156 per cent, whereas the proportion of public (government) debt has rocketed up from 69 per cent of GDP to 104 per cent of GDP.

The second graph (graph 2) shows how China’s debt-to-GDP ratio has risen from 158 per cent in 2007 to 282 per cent last year, with the latest reading at a level generally regarded as sufficient to trigger a debt crisis.

An illustration adjoin the China debt graph includes a snapshot of Australia’s debt structure, with the overall total not that much less than that of China (274 per cent of GDP) but with the lion’s share (113 per cent) being carried by private households compared with 38 per cent in China.

Sliced and diced in whatever way suits an argument, the underlying message is that the world has been on a debt binge for the past seven years, thanks partly to ultra-low interest rates, and shows every sign of continuing its orgy of debt creation with only a limited focus on creating the growth essential to pay back what’s owed.

Increases in debt-to-GDP ratios are led by Ireland, where the ratio has risen by 172 per cent since 2008. Greece is up by 103 per cent, China is up by 83 per cent, and Australia is up by 33 per cent.

“Overall debt relative to GDP is now higher in most nations than it was before the crisis,” McKinsey said before delivering the blindingly obvious judgment that: “higher levels of debt pose questions about financial stability”.

While Australia has a debt bomb ticking under its economy, the sector to watch most closely is that classified as ‘emerging’, with almost half the new debt created over the past seven years being in developing economies – the same sector being buffeted by today by the collapse in commodity prices.

McKinsey does not offer a solution to the debt crisis, merely noting that there are few indications that the current trajectory of rising leverage (debt) will change.

“This calls into question basic assumptions about debt and the de-leveraging and the adequacy of tools available to manage debt and avoid future crisis,” McKinsey said.

Translated from management speak, McKinsey seems to be saying that: ‘We don’t know how to fix the problem and that even if we did governments might not have the stomach to do what’s required because they fear losing an election more than they fear ruining the economy.’


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