Global Debt
Global Debt
Global Debt
GLOBAL DEBT
A comprehensive insight into
the world’s largest bubble
A C A P I TA L I S T E X P L O I T S R E P O R T
GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
There is a scene in the movie Thelma and Louise where near the end, Thelma, played by Geena
Davis and Louise, played by Susan Sarandon are being chased by law enforcement officers
across the desert. Knowing that they have nowhere to turn to and not wishing to give themselves
up they put their foot on the accelerator and floor it, thereby ensuring their own deaths as they
drive straight off a cliff.
It’s an iconic movie, which sadly depicts accurately what Central Bankers today, having
abandoned any modicum of responsibility, are doing as they drive the monetary car at full-speed
towards a gaping ravine.
Excessive accumulation of debt was at the very heart of the global financial crisis that ripped
through the global economy crippling many of the world’s largest financial institutions, and
bringing many others to their knees. This debt accumulation was a direct result of easy monetary
policies repeatedly enacted by successive Central Bankers in the developed world.
The easy monetary policies have brought us successive bubbles, and with each collapsing
bubble a new larger one has been created. It is a commonly used phrase that the Fed is the
“lender of last resort”. The Fed, together in concert with global Central Banks has been lending
as a matter of last resort to such an extent that the largest bubble of all now stands, giant and
overbearing, above us all. That bubble is in the global debt markets.
This is the backdrop through which we view today’s global debt markets. It’s a background and
history of increasing Central Bank intervention, increasing regulation, increasing government
oversight and unsurprisingly, increasing fragility.
One would think that the lessons learned from the 2007 crash would be burning red hot in the
minds of Central Bankers, and market participants, both private and public alike. One would
think that massive de-leveraging would be de-rigueur.
One would be horribly mistaken, as we’re going to show you in this report.
Argentina has defaulted again, and France has announced rather ceremoniously that they
consider 60% of their debt to be “illegal”. The wheels are coming off. I’m reminded of
the famous quote in the book The Sun Also Rises, by Ernest Hemingway. “How did you go
bankrupt?”, he writes. “Two ways. Gradually then suddenly.”
Each successive crisis has been met with a re-inflation of an asset bubble. It hasn’t been the same
asset class, as the Central Banks don’t have control over where the money flows, only that the
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
money does indeed flow. This is how we have experienced asset bubbles and re-bubbles and
re-re-bubbles. This is the new normal, the way the world operates, and the danger to us is in
thinking that this will last - that this is indeed the way things will be, as a matter of course.
The disconnect between fundamentals and reality could not be more dramatic. Take for example
the move by the ECB to take European interest rates negative as Europe’s economies continue
to falter and as government debt levels climb ever higher.
If what we experienced in the Global Financial Crisis (GFC) was proportional to the level of debt
in the system at the time, then expect the GFC of 2007-08 to look like a speed-bump on the way
to a concrete barrier when compared with what’s coming.
While the developed world continues to gorge itself on debt, many of the Emerging Markets
have not done so and are sporting far healthier balance sheets.
In this report we lay out the blueprint behind a decision we made some 5 years ago. We made
a radical shift, moving much of our capital out of developed markets and into rapidly-growing
Emerging and Frontier markets. We’ve written extensively about this within the pages of http://
capitalistexploits.at/ .
Not only did we move much of our capital out of developed markets, but we moved it out
of public markets into private markets and privately run companies. The markets I’m talking
about are markets where leverage is a fraction of that employed in many developed markets,
markets which are growing as a result of less, not more regulation; less not more Central Bank
interference; and less not more “oversight”.
What grew out of this investment strategy was a small and exclusive syndicate of global
investors and entrepreneurs that share our views, and now invest alongside us in private, curated
opportunities, which we source globally. The group is known as Seraph. After reading this report
if you want to know more about Seraph you will find our contact information at the end.
To conclude this introduction let us say that debt is both the great enabler as well as the great
destroyer of civilizations. We’re of the strong opinion that it should not be taken lightly.
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
According to the Bank for International Settlements (BIS) [1], global debt reached $100 trillion in
mid-2013, having grown by 40% since the onset of the global financial crisis (from $70 trillion in
mid-2007):
Source: [1].
Of the $100 trillion, $43 trillion has been issued domestically by governments – an approximately
80% increase since 2007 when debt had reached such completely unsustainable levels as to bring
us the GFC.
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
As you can see from the chart below the developed or “advanced” world economies have taken
on completely unsustainable levels of debt, with virtually every major Western country gorging
on ever increasing amounts of debt.
The next chart shows us where the majority of this debt is coming from.
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
Central Bank balance sheets have quite simply exploded, thus promising us all a day of
reckoning. When this day will come is the $64 million question. That it will come is no longer
up for debate. While populist economists such as Paul Krugman are of the opinion that ever
increasing debt is possible, we believe that history proves otherwise.
The Wall Street Journal has compiled an interactive chart [2] of countries’ relative debt positions
between 1990 and 2012. Below we show the starting and ending charts. The difference between
the two I think speaks for itself.
Source: [2].
Source: [2].
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
The trend is unmistakable, and due to the sheer size of debt in many countries, it now appears
virtually unstoppable. Certainly the political will to change course is not currently present.
An IMF working paper [3] shows central government debt levels as a percentage of GDP in
developed and emerging economies. It shows that advanced economies’ government debt is at
levels not seen since immediately after World War 2, when countries (understandably) borrowed
aggressively in order to rebuild their economies.
Source: [3].
The working paper authors argue that, “Total external debt is an important indicator because
the boundaries between public and private debt can become blurred in a crisis. External private
debt (particularly but not exclusively that of banks) is one of the forms of ‘hidden debt’ that
emerge out of the woodwork in a crisis.
“Just as bank balance sheets before the 2007–09 financial crisis did not reflect the true
economic risk these institutions faced, official measures of public debt are typically a significant
understatement of vulnerability.”
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GLOBAL DEBT
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It is therefore important to look at total (public+private) external debt. Here, the difference
between developed and emerging economies is stark: as Emerging Markets have been de-
leveraging, advanced economies have done exactly the opposite, but at a much faster pace.
Source: [3].
Source: [3].
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GLOBAL DEBT
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As mentioned in the prelude to this report, our personal wealth is largely invested in, and
devoted to, private equity, much of it in Emerging and Frontier markets, where debt levels both
private and public are fractions of those in the developed world. I’m reminded of a famous “rule”
of Warren Buffets: “Rule No 1: Never lose money.”
Investing in economies and businesses which hold substantially less debt than their developed
world counterparts, while experiencing growth rates many times those enjoyed in developed
markets, goes a long, long way to reducing downside investment risk.
In its recent Economic and Investment Outlook Report [4], Vanguard cautions readers about
high government and private sector debt. The report presented the following heatmap to
illustrate its point.
Source: [4].
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GLOBAL DEBT
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The scary facts behind us, let us now look at some of the main “culprits”, or “players” in this
global, mammoth debt binge.
United States
As long as the U.S. Dollar is the primary international reserve currency, the U.S. government has
an advantage of being able to print as much as it needs to settle its debt, both domestic and
international. Not surprisingly, the U.S. debt has been rising over the past few decades, both in
absolute terms and as a percentage of the country’s GDP.
Public debt
The combined debt of the federal government and of local/state authorities has grown 11-fold in
the past 30 years: from $1.4 trillion in 1982 to $15.3 trillion in 2013. With GDP having grown only
5-fold, the relative size of debt as a percentage of GDP has thus more than doubled – from 42%
to 91% within this period:
The relative size of federal debt as a percentage of GDP is the highest since World War 2.
Source: [29].
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
This is where things get interesting. One could always ask the obvious question; how has this
been sustained for this long already? The answer is to be found in the cost of capital. Although
debt has risen versus GDP, interest payments as a percentage of GDP have remained relatively
stable, as yields are at historic lows:
Source: [21].
Holding interest rates low, and indeed pushing them ever lower has been at the forefront of
Central Bank policy, enabling debt levels to continue rising while the cost of servicing said debt
has remained stable or indeed fallen. In a normal functioning economy rising debt levels are
typically associated with rising interest costs since the default risk rises with increased leverage.
Clearly we are experiencing the exact opposite situation.
It doesn’t take a mathematical genius to see the problems in this Central Bank strategy, namely
it’s a problem of increasing fragility. It is a problem which Central Bankers of near perfect
ignorance have time and again chosen to ignore, instead passing an ever expanding problem on
to successive administrations; it’s a problem to be solved ”in the future.”
The rationale behind this particular strategy is that growth will be achieved in the short term,
which will then allow for a de-leveraging of debt to take place, all based on a healthy, resurgent
economy. As is often the case with “short term”, “emergency” policies they are rarely short
term, but rather enacted as policy, thereby increasing the risk to the system. The premise is that
growth can be achieved by money printing, which if it were true Zimbabwe would be one of the
most prosperous countries on earth!
That Central Bankers are appointed not for competence, but allegiance, provides the answer
to how we find ourselves in such a predicament. A more thorough discussion is required to
understand Central Bank policy, the Federal Reserve, the ECB, the BOJ and numerous other
culprits, but that is a discussion not intended for this report. In this report we are looking simply
at the global debt build-up.
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
Now that we’ve dealt with public debt let us move on to private debt…
Mortgage debt
Mortgage debt is by far the largest component of household debt in the United States,
representing about 70% of the total, as the following chart shows.
Source: [31].
The next chart provides some more historical perspective. Total mortgage debt [5]1 grew from
$45 billion in 1949 to $13.2 trillion in Q4-2013, an almost 300-fold increase.
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
Similar to public debt, mortgage debt’s relative size has grown, and although there has been a
decline after the 2008 crisis, debt levels remain massively elevated by historical standards: Just as
with public debt mentioned above, so too private households are enjoying historically low interest
costs allowing for higher debt burdens to remain manageable.
As the chart above shows, consumer credit’s share of GDP has not shown a similar decline in
recent years, reflecting the rising balance of student loans (see below).
The burden of mortgage payments had been rising steadily until the 2007-2008 crisis, with a significant
decline since then, reflecting the decline in outstanding mortgage balances and their share of GDP.
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
Vanguard notes [4] the de-leveraging trend among U.S. households, estimating that, “Although
this debt may not reach more sustainable levels of 60%–70% of GDP until 2016 or so, lower
interest rates to service it combined with rising stock and home values have substantially aided
the transition to a ‘passive de-leveraging’ phase of the cycle.”
Source: [28].
Given the long-term growth trend in consumer debt as a percentage of GDP (as shown in the
chart above), it is probably logical to expect debt to rise once again, unless some far-reaching
actions are taken to curb excessive lending and borrowing.
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GLOBAL DEBT
Student loans
A comprehensive insight into the world’s largest bubble
According to the Federal Reserve Bank of New York, “Student loan debt is the only form of consumer
debt that has grown since the peak of consumer debt in 2008”, this represented 10% of total U.S.
household debt in Q1-2014 (second largest debt type after mortgages). Student loan debt has grown
to $1.25 trillion as of Q1-2014 [6], “two-thirds of graduating students are carrying some form of debt”
[7], according to the CFA Magazine [8]. This is more than a 4-fold increase from less than $300 billion
in 2004 [9]. The sharp rise in total student debt balance is evident in the chart below.
Source: [9].
The sharp increase came as a result of compounding the rising number of borrowers by an
increasing average loan size (+70% each between 2004 and 2012).
Source: [9].
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To compound the problem, the share of delinquent student loans has been growing steadily
during the past 10 years, with a sharp jump above 10% in 2012, as the following chart shows.
Source: [31].
An article in the January/February 2014 issue of the CFA Magazine [8] made the following
conclusions about the student debt market:
• The so-called higher education bubble may be near collapse, with private banks exiting the market.
• Changes in the higher education market likely will lead to structural changes as well as
“creative destruction”.
• Student loan indebtedness may have systemic implications for investors, economic growth, and
fiscal/monetary policy.
In addition, the article reports that, “The federal government is withholding money from the
rapidly growing number of Social Security recipients who have fallen behind on federal student
loans incurred to educate their children”, quoting about 115,000 such cases in the most recent
quarter, which was twice as many as in 2007.
Once again a problem that is only exacerbated by existing policies, and for which the only real
solution is a reduction in excessive borrowing. Obama’s latest “plan” is not a solution. It will only
add more weight to the camels back.
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
EU
The EU’s government debt had been following a downward trend (as percentage of GDP) until
the crisis, which wiped out all progress, as government debt grew from the low of about 60% of
GDP to almost 90% by the end of 2013.
Source: [23].
The relative size of interest payments has declined over recent decades despite the recent
growth in the relative size of debt.
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GLOBAL DEBT
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The graphs below show the anomaly mentioned at the beginning of this report, namely declining
interest costs for government debt. The graphs show France, Spain and Italy’s 10yr yields
declining to the lowest levels in history.
Source: [32].
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GLOBAL DEBT
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There are no readily available consolidated statistics for the EU’s private debt, but individual
country charts clearly show a growing trend (in terms of percentage of GDP).
Source: [22].
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GLOBAL DEBT
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Japan
The Land of the Rising Sun is a prime example of excessive government debt growth, with a
current debt/GDP ratio over 200% - well above any other developed country. With the Japanese
economy stagnating for decades the debt burden has been growing since 1975.
Source: [10].
Source: [27].
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GLOBAL DEBT
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Like other developed countries, growth in debt has not been associated with a similar rise of debt
service cost as a percentage of GDP due to low interest rates. It’s a coiled spring if ever there was one.
Source: [10].
Source: [32].
As Global Financial Data notes, “With an ageing population, no population growth, and low
interest rates with savings absorbed by the government, it is difficult to see how Japan can ever
return to any level of economic growth. Every country caught in the current financial crisis would
be wise not to follow in Japan’s footsteps.” [10]
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China
Public debt
EconoMonitor notes [11], “Due to unreliable data and measurement problems, the exact level
of [China’s] debt remains unclear. Most estimates now put Chinese government (including local
governments), corporate and household debt at around 200-250% of GDP, up from around 140-
150% in 2008”. The same source quotes China’s National Audit Office as reporting the level
of government debt, including local government debt, of about 55% of GDP (~US$5 trillion)2,
60% above the 2010 level. At the same time, the article asserts that the debt of many state-
owned enterprises, banks and other institutions is not included; with these, government debt is
estimated at about 90% of GDP.
Source: [26].
International Business Times notes [12] that the debt of China’s local governments, “Is not known,
even by the central government”, with analyst estimates putting it between 30% and 60% of China’s
GDP. Local government debt is being driven by excessively ambitious infrastructure and real estate
projects, such as those announced by the Sichuan authorities in October 2013, which included,
“Three highways, five railroads and what would be the largest airport in West China”, and whose
value was reportedly ten times the fiscal revenues and double the province’s GDP for the 2-year
period during which the projects were to be implemented.
Ghost cities are a typical example of China’s wasted (and financed with debt) resources, in some
cases with enough apartments to house the local population several times over.
2 Apparently, this includes $1.6 trillion in contingent obligations. Without these, government debt would equal about 39% of GDP.
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Ironically, local governments bear 80% of all government expenditures, but have only about 40-
50% of necessary revenues [13], and they are not allowed to borrow directly (since as far back as
1994, although a trial municipal bond program was launched in 2011), yet the central government
has tasked them with supporting the economy through infrastructure projects [12]. As a result,
local authorities have been using local-government financing vehicles (LGFVs) – state-owned
companies that borrow money from banks or through bonds.
Herein lies one of the main risks: according to some estimates, LGFVs often borrow from shadow
banks, which represent more than a third of the debt issued by traditional banks, and about half
of China’s GDP – up from a quarter of GDP only five years ago.
According to HSBC, “The root cause of the problems associated with local government debt
and shadow banking is the fact that a financial system dominated by banks can no longer cope
with the demands of financing rapid urbanization”. Notably, shadow banks do not comply with
financial regulations and often demand shorter maturities and higher interest rates, putting the
country’s financial system on very shaky ground. In the words of a Societe Generale’s analyst,
“Funding infrastructure projects with 10 percent-per-year interest rates and less than two years
maturity looks dangerously like a Ponzi scheme for GDP creation.”
According to estimates by Nomura, more than half of LGFVs could have defaulted on their debt
in 2012 without liquidity support from local governments. In addition, Morgan Stanley estimates
[13] that a third of new local government borrowing is used to roll over existing debt, and that
interest payments represent 17% of China’s GDP.
Private debt
According to EconoMonitor [11], business and household debt grew by about 50% between
2008 and 2013 to 150-170% of GDP from 100-115%. Household debt doubled during this period
from 20-30% to 40-50% of GDP, driven by rapidly rising home prices and general inflation.
Morgan Stanley puts [13] the private debt level at 193% of GDP at the end of 2013 – significantly
higher than 115% of GDP in 2007.
According to Pieter Bottelier [13], a senior adjunct professor at Johns Hopkins University’s School
of Advanced International Studies in Washington, D.C., China’s corporate debt as percentage
of GDP is at a relatively high level, and much of it is invested in real estate, making the economy
vulnerable to a prolonged decline in property prices.
According to a 2012 Bank of International Settlements (“BIS”) study [14] of national debt
servicing ratios (“DSR”), DSRs above 20-25% often indicate heightened risk of a financial crisis. As
EconoMonitor notes [11], “Analysts have estimated that China’s DSR may be around 30% of GDP
(around 11% goes to interest payment and the rest to repaying principal), which is dangerously high.”
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GLOBAL DEBT
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Emerging Markets
Though we talk about Emerging Markets as a whole, vast differences exist from country to
country. As a whole Emerging Markets hold substantially less debt than their developed world
counterparts. At the same time, their economies and banking systems are typically more fragile
and susceptible to adverse capital flows than larger economies. Violent currency movements can
affect emerging-market economies more rapidly than larger developed markets, as the Asian
crisis of 1997 showed us.
An IMF working paper [15] reports that Emerging Markets debt levels have been on a more
sustainable level over the past decade than that of developed economies.
Source: [15].
In an article on MarketWatch [16], Satyajit Das wrote in September 2013 that Emerging Market
debts had risen by 10-30% since 2008, depending on the country, with Asian economies
recording especially high growth rates. According to the article, a debt to GDP ratio of 150-200%
“is now common”. At the same time, capital intensity of economic growth had doubled to $4-$8
of new debt per each $1 of additional GDP growth.
According to Satyajit Das, consumer credit has grown too. In Thailand and Malaysia it reached
80% of GDP, “Up sharply from levels in 2007.” In Thailand, debt payments represent more than
one-third of income.
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GLOBAL DEBT
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One of the major problems for Emerging Market borrowers is hard-currency debts. These carry
low interest rates but subject the borrowers to higher risk should their domestic currencies fall
against the debt currency. Brazil for instance has dollar debt worth 12% of its GDP, Turkey – 22%,
India has foreign debt worth 20% of GDP. That being said, the overall levels of government
debt are generally low (except in India and China), but government involvement with banks and
industry increases their off-budget exposure.
Recent years have seen a rise in non-performing loans. Satyajit Das reports that 12% of total assets
in Indian state-owned banks are represented by either bad or restructured loans – this is double
the level of four years ago.
In a blog post on the CFA Institute website, Larry Cao, CFA notes [17] that quantitative easing in the
developed economies and other external factors, coupled with low interest rates, were the primary
reasons for the large inflow of cash into Emerging Markets debt, accounting for 60% of the increase in
capital flows to Emerging Markets between 2009-2013. This has made Emerging Markets vulnerable
to “tapering” measures in developed economies. At the same time, interest rates appear to be rising,
which is likely to change the economic environment for Emerging Market debt in the near future.
Corporate debt
Business Insider quotes Nomura [18] estimates, according to which Emerging Market corporations
have issued $400 billion in offshore debt since 2010, which represents 40% of total issuance. The chart
below illustrates the sharp increase in debt issuance since the start of the 2007-2008 crisis:
Source: [18].
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GLOBAL DEBT
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According to Nomura, “This issuance is not captured in traditional country-level balance of payments
statistics, which only measure debt issuance on a residency basis and not a nationality basis. In other
words, the official statistics only measure a given corporation’s debt issuance in the home country, and
don’t take into account offshore debt issued through overseas subsidiaries.” Nomura analysts believe
this “hidden” debt, “Could pose a major risk for EMs in which currencies are rapidly declining against
the dollar.”
Bloomberg quotes the IMF [19] saying that Emerging Market corporate debt tripled between 2009
and 2013 as a result of expansionary policies in developed countries, “With debt levels in countries
such as China, Hungary and Malaysia reaching or exceeding 100 percent of gross domestic product.”
A simulation model run by IMF, which assumes a 25% increase in borrowing costs combined with a
25% drop in corporate earnings across 15 Emerging Markets countries, suggests that emerging-market
companies, with their $740 billion in foreign debt (35% of total), “Could find it hard to service their
obligations.” Argentina, Turkey, India and Brazil are among the weakest economies in this regard.
Above we have the Greek 10-year bond yield, which as you can see was for some time sailing
along smoothly at around a 5% yield, only for the wheels to come of the Greek government bond
market with interest costs soaring to over 30%. The problem always gets solved, the question is
only who is left holding the bag and who loses their shirt. When debts cannot be repaid you can
rest assured that somebody will pay the price.
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A well known example includes Argentina, a country which has a colourful history when it comes
to fiscal policy. The above chart is not unlike the Greek one and shows how things appeared to
be coasting along just fine, until it suddenly they weren’t, and debt servicing costs soared.
Russia – A Template
The Russian ruble crisis is we believe a wonderful template, which we’ll spend a little time on. It
portrays how things can go horribly wrong in a hurry, and how when the inevitable does in fact
happen, it affects all market participants, not just those holding debt instruments in the given country.
We’d Like to show you the graph below, whilst highlighting the spike in the middle of the graph. This
of course is the cost of debt blowing out like a well-timed geyser at Yellowstone National Park.
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GLOBAL DEBT
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How Russia got to this point is worth reviewing. Let us take a meander down memory lane.
Abbigail J. Chiodo and Michael T. Owyang have written a paper on the Russian Currency Crisis
[33], which provides a very good anatomy of the crisis.
April 1996 – Negotiations with the Paris and London Clubs for repayment of
Soviet debt begins.
1997 – Trade surplus moving toward balance
– Inflation around 11%
– Oil selling at $23/barrel
– Analysts predict better credit ratings for Russia
– Russian banks increase foreign liabilities
– Real wages sagging
– Only 40% of workforce being paid fully and on time
– Public sector deficit high.
September/October 1997 – Negotiations with Paris and London Clubs completed.
November 11, 1997 – Asian Crisis causes a speculative attack on the ruble
– CBR defends the ruble losing $6 billion
December 1997 – Year ends with 0.8% growth
– prices of oil and non ferrous metals begin to drop
February 1998 – New tax code submitted to the Duma
– IMF funds requested
March 23, 1998 – Yeltsin fires entire government and appoints Keriyenko
– Continued requests for IMF funds
April 1998 – Another speculative attack on the ruble.
April 24, 1998 – Duma finally confirms Keriyenko’s appointment
Early May 1998 – Dubinin warns government ministers of impending debt crisis, with
reporters in the audience.
– Kiriyenko calls the Russian government “Quite poor”
May 19, 1998 – CBR increases lending rate from 30% to 50% and defends the ruble
with $1 billion
Mid May 1998 – Lawrence Summers not granted audience with Kiriyenko
– Oil prices continue to decrease
– Oil and gas oligarchs advocate devaluation of ruble to increase
value of their exports.
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May 23, 1998 – IMF leaves Russia without agreement on austerity plan
May 27, 1998 – CBR increases the lending rate to 150%
Summer 1998 – Russian government formulates and advertises anti crisis plan
July 20, 1998 – IMF approves and emergency aid package (first disbursement to be
$4.8 bilion)
August 13, 1998 – Russian stock market, bond, and currency markets weaken as a
result of investor fears of devaluation; prices diminish
August 17, 1998 – Russian government devalues the ruble, defaults on domestic debt,
and declares a moratorium on payment to foreign creditors.
August 23-24, 1998 – Kiriyenko is fired
September 2, 1998 – The ruble is floated
December 1998 – Year ends with a decreases in real output of 4.9%”
Above is a graph showing the devaluation of the ruble. Remember the ruble crisis is what brought
LTCM crashing back down to reality. Fear not for LTCM though, the founders will be just fine.
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GLOBAL DEBT
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Who really got screwed were Russians who saw their purchasing power crumble as inflation
soared. As the ruble came under pressure inflation soared to a high of 84%, shelves were
emptied as Russians everywhere emptied their wallets in favour of food, or in fact anything other
than rubles. Millions of people lost their life savings as banks collapsed, and social tensions
erupted across the country resulting in demonstrations in cities across Russia.
All of this is merely anecdotal and has been repeated multiple times throughout history. It should
not ever come as a surprise but it always does.
So next time some Central Banker tries to assure you that printing money and debt default are
not in any way aligned I encourage you to place yourself in the shoes/boots of the Babushkas in
the photo below, lining up to buy old food at ludicrous prices!
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
Conclusion
Based on historical experience, debt burdens can be reduced five ways [3]:
• Economic growth
• Fiscal adjustment-austerity
• Explicit (de jure) default or restructuring
• Inflation surprise
• A steady dose of financial repression accompanied by a steady dose of inflation.
The most benign – economic growth – provides little hope as global trends suggest, with the
other four options remaining the bitter medicine for today’s over-borrowing illness.
In an IMF working paper titled, “Financial and Sovereign Debt Crises: Some Lessons Learned and
Those Forgotten” [3], the authors summarise the current naivety of policy-makers (emphasis is ours):
“In Europe, where the financial crisis transformed into sovereign debt crises in several countries,
the current phase of the denial cycle is marked by an official policy approach predicated on the
assumption that normal growth can be restored through a mix of austerity, forbearance, and
growth. The claim is that advanced countries do not need to apply the standard toolkit used by
Emerging Markets, including debt restructurings, higher inflation, capital controls, and significant
financial repression. Advanced countries do not resort to such gimmicks, policymakers say. To do
so would be to give up hard-earned credibility, thereby destabilizing expectations and throwing
the economy into a vicious circle. Although the view that advanced country financial crises are
completely different, and therefore should be handled completely differently, has been a recurrent
refrain, notably in both the European sovereign debt crises and the U.S. subprime mortgage
crisis, this view is at odds with the historical track record. In most advanced economies, debt
restructuring or conversions, financial repression, and higher inflation have been integral parts of
the resolution of significant debt overhangs.
[…] Research shows that a debt overhang of this size is typically associated with a sustained
period of sub-par growth, lasting two decades or more. In light of this dim prospect, the
paper reviews the possible options, concluding that the endgame to the global financial crisis
is likely to require some combination of financial repression (an opaque tax on savers),
outright restructuring of public and private debt, conversions, somewhat higher inflation,
and a variety of capital controls under the umbrella of macro-prudential regulation. Although
austerity in varying degrees is necessary, in many cases it is not sufficient to cope with the sheer
magnitude of public and private debt overhangs. All these options, understandably anathema to
the current generation of advanced country policymakers, are more familiar to their economies
than is commonly recognized.”
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
As a concluding remark, we would like to include another quote from Global Financial Data [10]:
This concludes the report. It’s brief but sobering, we think you’ll agree.
P.S. Remember, if you enjoyed this report please share it with your friends.
If you are interested in finding out more about our exclusive investment group, Seraph,
please drop us a note at: admin@seraph.vc
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
Sources:
[1] http://www.bis.org/publ/qtrpdf/r_qt1403.pdf.
[2] http://graphics.wsj.com/national-debts/#i[]=999.
[3] http://www.imf.org/external/pubs/ft/wp/2013/wp13266.pdf.
[4] https://personal.vanguard.com/pdf/ICREIO.pdf?utm_content=sf1429484&utm_
medium=spredfast&utm_source=twitter&utm_campaign=Personal+Investor&sf1429484=1.
[5] http://www.federalreserve.gov/.
[6] http://www.federalreserve.gov/releases/g19/current/default.htm.
[8] “Wise Guise” by John Rubino, January/February 2014 issue of the CFA Magazine.
[9] http://www.newyorkfed.org/newsevents/mediaadvisory/2013/Lee022813.pdf.
[10] https://www.globalfinancialdata.com/news/articles/government_debt.pdf.
[11] http://www.economonitor.com/blog/2014/04/chinas-debt-vulnerability/.
[12] http://www.ibtimes.com/chinas-local-government-debt-crisis-though-heavily-leveraged-
linked-shadow-banks-provincial-1442176.
[13] http://knowledge.wharton.upenn.edu/article/chinas-ticking-debt-bomb/.
[14] http://www.bis.org/publ/qtrpdf/r_qt1209e.pdf.
[15] http://www.imf.org/external/pubs/ft/wp/2013/wp1393.pdf.
[16] http://www.marketwatch.com/story/why-emerging-markets-are-going-nowhere-
fast-2013-09-06.
[17] http://blogs.cfainstitute.org/investor/2014/05/28/emerging-market-debt-an-overlooked-
source-of-alpha/.
[18] http://www.businessinsider.com/the-hidden-debts-of-russia-and-ukraine-2014-3.
[19] http://www.bloomberg.com/news/2014-04-09/imf-sees-rising-risks-for-emerging-markets-
corporate-debt.html.
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
[22] http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&init=1&plugin=1&language=e
n&pcode=tipspd10.
[23] http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&init=1&plugin=1&language=e
n&pcode=tsdde410.
[24] http://www.federalreserve.gov/releases/housedebt/default.htm.
[25] http://www.federalreserve.gov/releases/z1/Current/z1.pdf.
[26] http://www.tradingeconomics.com/china/government-debt-to-gdp.
[27] http://www.tradingeconomics.com/japan/government-debt-to-gdp.
[28] https://personal.vanguard.com/pdf/ICREIO.pdf?utm_content=sf1429484&utm_
medium=spredfast&utm_source=twitter&utm_campaign=Personal+Investor&
sf1429484=1.
[29] http://en.wikipedia.org/wiki/History_of_the_United_States_public_debt.
[30] http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&904=1
980&903=5&906=a&905=2013&910=x&911=0.
[31] http://www.newyorkfed.org/householdcredit/2014-q1/data/pdf/HHDC_2014Q1.pdf.
[32] http://www.oecd-ilibrary.org/.
[33] http://research.stlouisfed.org/publications/review/02/11/ChiodoOwyang.pdf
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GLOBAL DEBT
A comprehensive insight into the world’s largest bubble
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