The more things change, the more they stay the same. This old adage certainly seems appropriate when it comes to people and money. Remember back in 2006, about a year before the housing bubble popped and the stock market collapsed? Times were good, or so it seemed. But money has a funny way of making things seem better than they actually are; especially when that money is borrowed. We all know what happened in 2007 when that borrowed money came home to roost. Well flash forward to today. We are roughly 10 years removed from the worst financial crisis since the Great Depression. But, yet we find ourselves in nearly the exact same place financially that we were in just prior to the 2007 Great Recession.
Massive Increase in Debt
According to the International Monetary Fund’s Global Financial Stability Report, non-financial debt levels have risen “to $135 trillion, or about 235 percent of aggregate global GDP in 2016, surpassing the debt –to-GDP ratio of 210 percent in 2006.” Just what this means for both the short and long-term is still anybody’s guess. However, this massive increase in leverage, driven by non-financial borrowing, is very worrisome. Nearly all of this borrowing has been fueled by extremely low borrowing costs. But what happens when borrowing rates increase? And they will increase! These non-financial borrowers will be hit two-fold. First, an increase in interest rates will cause payments on the majority of this debt to increase. Cash strapped consumers and municipalities will struggle to meet these new obligations. Consumers will be doubly hurt; not only will their own payments increase, but almost assuredly their taxes will increase to cover the increase in municipal borrowing. Second, an increase in interest rates will decrease borrowing, which is main fuel of the global economy. Consumer spending accounts for roughly 70% of GDP and the vast majority of that spending is from borrowing.
The next market correction is unavoidable. Just this week the Dow Jones topped 24,000 for the first time in history. Borrowing costs are still at record low levels. Just what role this massive increase in non-financial leverage and its inevitable de-leveraging will play in the next correction is unknown. However, it was exactly this kind of de-leveraging that caused the market collapse in 2007.
Unfortunately, the more things change, the more they stay the same.