Market Update 30th October 2023

All the money in the world

Which is the most indebted country in the world and what measure are we using? We are looking at the percentage of government plus non-financial corporate debt to GDP. No prizes if you said Japan, way out in front with 417%, but I would be impressed if you knew who was second – it is France with 333%. China is a solid third with 307%, Switzerland an eye-opening fourth with 304%. Other notable entries – the US is 254%, UK is 243%, and Germany 189%.

What about their ability to pay – perhaps a better way of looking at how stretched they are? Japan’s debt service ratio (the ratio of debt service payments to export earnings) is 15.7% – mid-table obscurity when you look at it this way. UK and US are again in the same ball-park as each other – 13.9% and 14.9% respectively. Norway though is up at 25.8%, Canada 23.8% – very close to its peak of 24.4%, France – high up the table again – is 20.5%.

Whether it is governments or football teams, debt has become something of a dirty word, but is a key driver of economic growth. In the US, all categories of debt have increased markedly since 2008 in nominal terms but overall debt levels have stayed about the same as a percentage of GDP. But within that steady overall number, the government share has doubled from about 60% to 120%, while commercial bank held debt has fallen from 120% to 80% and household debt has also fallen substantially as a percentage. The US government quite rightly stepped into the gap left by banks in the 2008 crisis, to avoid a large-scale credit contraction.

They have been issuing higher levels of treasuries ever since and 2023 has become the second biggest year on record for US treasury issuance at nearly $2tn. This is because the US government is trying to fund its large deficit, while taking less money in taxes. The biggest year was 2020 with just over $4tn. Since 2008, it has tended to hover either side of $1tn. 2024 is expected to be another big year. The supply of treasuries doesn’t usually affect the price – issuance increased hugely following the financial crisis with yields near zero. But this time, the biggest buyer of treasuries – the Fed, has been stepping back. So is China, another large buyer.

The Fed is stepping back because of its policy of quantitative tightening (QT) – the supply of money has been decreasing. But what about China? The theory is that while the rest of us are worrying about inflation and the price of a sandwich in Pret, China is hovering on the edge of deflation. Its year on year CPI was 0.1% in Q2 and -0.1% in Q3. This is a problem if China wants to inflate away the value of its debt. One reason China buys US treasuries is to help manage its own currency in a range around the US dollar. If inflating away the debt is part of their plan, they won’t be able to hold the value of their currency to the dollar and will buy fewer treasuries as the currency falls. We may be witnessing some very large global economic and geopolitical changes and I think it is not a coincidence that tensions have visibly increased.

One theory doing the rounds as a result of all this, is that most major developed market central banks are insolvent. The asset side of a central bank tends to be government bonds, which for over a decade now have low yields. Their liabilities are commercial bank reserves deposited with them. As with any bank, the central bank is really just trying to lend out at a higher rate than they pay on deposits and keeping the difference. But the interest rate on these deposits has been increasing, while they hold low coupon government bonds on the asset side.

Before you head for the hills with a tin of beans and a lot of loo roll, one key difference with a central bank is they are not expected to make a profit, and nor are they particularly trying to. It is only an issue if the central bank has to sell its bonds (currently at a loss) before they mature or if the central bank itself needs a bail out. Who is on the hook to bail out central banks? The same people that bailed out commercial banks in 2008 – me and you.

Robert Fullerton – Senior Research Analyst

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