Global leverage, examined

Despite post-crisis efforts to reduce debt, there's still lots of it around. 320 per cent of global GDP, to be slightly more specific.

A new report from macro wonks at HSBC Global Research landed in our inboxes late last week, containing all sorts of wonderful charts on the topic.

Here are three of the most interesting charts from the note.

Debt service ratios

The red bars show the effect of a one percentage point rise in a country's base interest rate on the percentage of household income currently spent on debt servicing, or the black dots. So in Finland, an interest rate rise of 100 basis points will push the per cent of income spent on interest payments up 38 (or so) basis points, from 7.4 per cent of income, to 7.7 per cent of income.

Two things stick out in this chart, neither of which neatly align with the post-crisis narrative.

First, some of the world's most stable economies, such as Australia and Canada, are the most sensitive to rate rises. Reasons vary, but both Australia and Canada are exposed to the same global forces.

Australia, as Dan highlighted in August, has a softening housing market, after nearly two decades of rocket-fuelled growth:

To keep up with the Joneses, Australian's have had to take on vast mortgages to afford housing. Low global rates, and thus affordable mortgage payments, have only accelerated this trend further. With the Fed raising rates, the Reserve Bank of Australia is under pressure to follow suit. Last week, it held its cash rate at 1.5 per cent after warning on tighter loan conditions in October. The threat to family incomes then, with falling house prices and potentially higher financing costs, is acute.

Canada, another commodity producing nation, faces similar headwinds. It too has had a ballooning urban property market, in part fuelled by overseas investor money (mostly from China) and low rates. See this FT chart of Vancouver property prices versus US neighbour Seattle:

So risks abound for those who are leveraged-long property in Australia and Canada.

The second, related point of interest is how countries often perceived as economic laggards — most notably the southern Mediterranean countries, such as Italy and Spain — are much less sensitive to rates. For all of its national finger-wagging on fiscal prudence, the average German household spends a larger portion of income on debt servicing than Italy.

Foreign currency debt, by country

Turkey and Argentina stared down economic collapse over the summer partly because the countries and its corporations owed too much debt. But it wasn't just any debt, it was debt denominated in US dollars.

As the dollar has strengthened roughly 10 per cent against its peers since mid-February, emerging market currencies have weakened. And as these local currencies fetched fewer greenbacks, repaying this debt became far more difficult.

Of course, what transpired in Turkey and Argentina was partly self-inflicted — Turkish President Recep Tayyip Erdogan eschewed economic orthodoxy and Argentina, at first, stalled on making (arguably) necessary fiscal cuts — but the volatility (which saw Turkey's lira lose a third of its value this year and Argentina's peso, nearly half) put emerging markets more broadly on high alert.

As contagion fears swept through global markets in August, a line formed between those with and without piles of dollar-denominated debt. As HSBC's chart shows, not all emerging markets had to worry. Roughly half of the debt held by Argentina's non-financial corporate sector in the first quarter of this year was dollar denominated. Mexico and Turkey's also held sizeable shares.

China's debt woes, on the other hand, have been much more of a domestic issue. Although its non-financial corporate sector is weighed down by debt-to-GDP levels upwards of 160 per cent, only a fraction has been dollar-denominated. What's more, should China's currency come under pressure, the country has a $3tn mountain of foreign exchange reserves to quell any concerns. Turkey and Argentina have had far sparser cushions to fall back on relative to the size of their economies.

Growth, still powering ahead

For HSBC, these elevated levels of debt are not yet a systemic threat because many countries are still growing at a relatively fast pace. In the arithmetic of the debt-to-GDP calculation, if the denominator is growing faster than the numerator, there's no problem.

GDP data in the third quarter, the analysts write, has been “steady” outside of the Eurozone, and an outright collapse of growth is not on the cards. What's more likely is a gradual growth slowdown, particularly if the high of Trump's tax cuts is not followed by more fiscal juicing stateside.

Of course, should the Federal Reserve accelerate its rate tightening timeline, emerging markets could feel pinched sooner as investors move into higher-yielding (and safer) US assets.

A final point HSBC makes regards the other side of countries' balance sheets, namely the assets the debt backs. Often, in the heated discourse over fiscal positions, commentators forget that the debt is sometimes taken on to fund assets. If we step back and look at global government assets minus debt, according to HSBC, nearly everyone is on sound footing. In other words, they hold some equity.

That is, except the UK:

. . . where a shortage of assets and large pension liabilities mean that the UK is the only country in the sample below where the level of net worth is worse than the simple government debt statistic implies.

With a certain geopolitical event looming on the horizon, some would argue this scenario is likely to get worse before it gets better.

Related Links:
Chinese real estate, charted — FT Alphaville
Since the crisis, a preference for debt markets over bank loans — FT Alphaville
One more reminder that the US dollar is dominant — FT Alphaville