Thursday, October 29, 2015

Why are the Federal Reserve's Hands Tied?

Now that the Federal Reserve has once again left investors baffled about their interest rate intentions, I wanted to take another look at an issue that may tie the Fed's "hands" for the foreseeable future.  Stuffed away in the Bank for International Settlements Quarterly Review dated September 2015 is some interesting information regarding the global debt situation.  As many of my long-term readers are aware, debt is a regular subject on this blog and this data from BIS shows us all how the global debt situation has reached the danger point.  

Let's start this posting by looking at a couple of definitions:

1.) Market value of debt is the amount for which a creditor (in this case, a nation) could exchange assets or settle a liability at any moment in time.  Market values tend to fluctuate significantly.

2.) Nominal value of debt is the amount that at any moment in time the debtor (in this case, a nation), owes to a creditor plus the amount of interest owing.   This amount is stable from the time of debt issuance until it is fully repaid, unless accrued interest has not be paid.

Now let's look at how the nominal (in blue) and market (in red) values of the core debt as a percentage of GDP of key advanced economies have changed since 2007:


For your information, the green bars represent the valuation effect (right-hand scale) which are estimates of the difference between the reported market and nominal values of the debt.  For given changes in market interest rates, the valuation effect increases with the duration of the debt instrument.

As we can see from the graphs above, the debt levels for all nations have risen substantially since the beginning of the Great Recession.  In fact, here is what has happened to the nominal debt levels of European nations, Canada, the United States and Australia as a percentage of GDP between the end of 2007 and the end of 2014:


On average, the debt-to-GDP ratio for these 12 advanced economies rose from 63.2 percent in 2007 to 108.3 percent in 2014, an increase of 45.1 percentage points.  Even the European debt transgressors of Italy, Portugal, Spain, Greece and Ireland have seen substantial increases in their debt levels despite their attempts to rein in their budgetary deficits.  The only thing that is saving these nations (and others) from total fiscal ruin are today's ultra-low interest rates on their debt instruments as shown on this graph which shows the yield on ten year bonds:


Let's close this section with a graph showing how the debt-to-GDP ratio for sovereign debt has changed since 2000 for both emerging economies (in yellow using left-hand scale) and advanced economies (in red using right-hand scale) with the shaded area representing the 25th and 75th percentile across all of the nations in the sample and the vertical line representing September 15, 2008:


Now that we've looked at a bit of detail on government debt, let's look at what has happened to the debt of households in both emerging and advanced economies with the same colour scheme as above:



Here is a graph showing what has happened to non-financial corporate debt as a percentage of GDP since 2000, again, with the same colour scheme as the earlier graphs:


Lastly, here is a graph showing what has happened to total non-financial debt (including government, household and non-financial corporate debt) since 2000 with the same colour scheme as used above:


Here is a table showing the core debt of the non-financial sectors, including government, households and corporations (non-financial) and how much that debt has changed as a percentage of GDP between the end of 2007 and the end of 2014 for both advanced and emerging economies:


Between 2007 and 2014, on average, among advanced economies, total non-financial sector debt as a percentage of GDP rose by 36 percentage points to 265 percent compared to 50 percentage points and 167 percent for emerging economies.  Looking in more detail we find that among advanced economies, the largest growth in non-financial sector debt as a percentage of GDP was found in Japan (77 percentage points), followed by France (72 percentage points) and Italy (53 percentage points).  As well,  Japan has the highest total non-financial sector debt as a percentage of GDP at 393 percent, followed by Sweden at 295 percent and Spain at 293 percent.  Among emerging economies, the largest growth in non-financial sector debt as a percentage of GDP was found in Hong Kong (103 percentage points), followed by China at 82 percentage points and Singapore at 59 percentage points.  As well, Hong Kong has the highest total non-financial sector debt as a percentage of GDP at 287 percent, followed by Singapore at 242 percent and China at 235 percent.


This data quite clearly shows us how the world, both advanced and emerging nations, has levered up during the period since the beginning of the Great Recession.  Rather than using the period of economic growth to reduce debt levels, governments, corporations and households have been lured into taking on additional debt, debt that will haunt all of us when the next recession arrives.  Thanks to the world's central banks, most particularly the Federal Reserve, we are now hooked on what has the appearance of cheap credit.   With the global economy slowing, these high levels of debt will prove to be a drag on future economic growth, showing us that the long-term economic impact of ZIRP, QE and other imaginative tools used by the world's most influential central banks since 2008 are effectively zero and may net out to be far worse than nothing and that the Federal Reserve has successfully tied its own hands when it comes to its future interest rate policies.



3 comments:

  1. I don't understand the point of looking at debt levels when there is no definite prospect of the debts having to be paid, and interest payments can still be made. If you are saying that interest rates cannot be raised because then the debt could no longer be serviced, then that is what you should be trying to demonstrate. I don't see that here.

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  2. That is exactly what I'm trying to demonstrate. Here's an example:

    http://viableopposition.blogspot.ca/2015/02/washingtons-looming-debt-problem.html

    High debt levels, both personal and government, put negative pressure on economic growth. That is why the Fed's hands are tied; interest rates rise and growth levels drop.

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  3. It's too bad that Central Bankers are too stunned to recognize this fact. The writing has been on the wall for years and now it's time to pay the piper!

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