Debt Trap Archives - the patient investor

December 21, 2022December 21, 2022

Nouriel Roubini: “We are in a debt trap”

Nouriel Roubini was mocked by the media — who christened him “Dr Doom” — because of his prescient warnings ahead of the 2008 global financial crisis.

He has now published a book identifying 10 mega-threats to the global economy.

First and foremost is the debt trap. Private and public debt has expanded from 100% of GDP in the 1970s, to 200% by 1999, 350% last year — advanced economies even higher at 420%, China at 330%. Inflation forces central banks to raise interest rates. High rates mean many debtors will be unable to repay.

If governments print money to bail out the economy they will cause further inflation — a tax on creditors and savers [negative real rates threaten collapse of the insurance and pension industry].

We face prolonged high inflation.

Central Banks hiking rates is misguided, economic crisis will be so damaging they will be forced to reverse course.

Supply shocks from pandemic, Russia-Ukraine war and China zero-COVID policy.

Fiscal deficits will rise due to increased spending on national security and reducing carbon emissions.

Twenty years of kicking the can down the road [short election cycle incentivizes this], with politicians unwilling to support short-term costs for long-term gain because they are unlikely to be in power to reap the rewards. Older voters are also unlikely to support change as they may not be around to reap the benefits.

Carbon emissions are increasing due to the energy crisis from Russia-Ukraine war. Carbon tax of $200/tonne required, currently $2.

We need to reduce our energy consumption.

Also increase productivity. Technology is the only solution. AI and automation could lift GDP growth, providing sufficient income to fund the changes needed.

But technology is also a threat. It provides more dangerous weapons which risk greater destruction in the next conflict.

Democracy is still the best system. Autocracies are often corrupt and way too much concentration of power [echo chamber] leads to mistakes. They also increase inequality and political instability.

Nouriel seems bullish on gold because of geopolitical tensions. Also “green metals” because of the need to reduce CO² emissions.

October 9, 2019October 12, 2019

Ultra-low interest rates may lead to a ‘debt trap’

The highly-regarded Stephen Bartholomeusz warns that central bank policies may lead to a ‘debt trap’:

“….With the world apparently re-starting the use of unconventional monetary policies even before central banks have extricated themselves from the legacies of a decade of those policies, there is a real risk that the impacts and the threats posed by their side effects will swell and that the world will be caught within what the BIS has previously described as a “debt trap’’ with no exit.

The other disturbing aspect of the [BIS] report is that it repeatedly says it is too early to assess the longer-term implications of the policies the central banks have employed.

Central bankers respond to the latest data – they respond to short-term signals – but the side-effects of their post-crisis policies have already been building for a decade and will continue to build while they maintain ultra-low or negative policy rates and keep buying bonds and other fixed interest securities to depress longer-term interest rates and suppress risk premia.

How those side-effects are unwound and how the banks extricate themselves from their policies and the legacies of those policies won’t be known until they try, but the potential for another crisis has been increased by the big surge in global leverage and the elevated asset prices the policies have encouraged.

Negative rates and quantitative easing and variations on those themes might, as the BIS report says, be useful additions to central bankers’ toolboxes but the past decade has shown they aren’t by themselves a panacea for economic ills and they bring with them potentially unpleasant side effects the longer they are in place.”

Debt traps occur when the interest rate needed to service the government debt is greater than the growth rate of GDP, according to former Fed governor Robert Heller:

“…In such a situation, debt service obligations grow more rapidly than the economy; eventually, the accumulated debt can no longer be serviced properly. In other words, the dynamics of the situation become unsustainable and a death spiral ensues.”

So far, central banks have responded by driving interest rates to record lows but unintended consequences are emerging, with low interest rates leading to low GDP growth. A feedback loop is emerging:

- Low interest rates

Australia: 10-Year Bond Yield

- Low bank interest margins

Australia: Bank Net Interest Margins

- Low credit growth

Australia: Credit & Broad Money Growth

- Low inflation

Australia: Underlying Inflation

- And low economic growth

Australia: GDP Growth

We are venturing where angels fear to tread: central banks trialing new policies without empirical evidence as to their long-term consequences.

Monetary policy should be administered judiciously, intervening only when the financial system is in dire straits, outside the realm of the regular business cycle. Instead monetary policy is treated as a panacea, the constant drip-feed building a long-term dependence on further stimulus.

The problem with ‘traps’ is that they are difficult to escape.

“If you find yourself in a hole, the first thing to do is stop digging.”

~ Will Rogers

[NOTE: I should clarify that Australia has relatively low fiscal debt and is not in any immediate danger of a debt trap. But the ‘lucky country’ would suffer severely from fallout if the US or China were caught in a debt trap.]

December 23, 2013

Russia 1998 crisis haunts Deutsche Bank analyst seeing China bust | Livemint

When the Deutsche Bank AG equity strategist [John-Paul Smith] looks at the country [China], he says he detects some of the same signs of a financial meltdown that led him to predict Russia’s 1998 stock market crash months in advance. China’s expansion is being fueled by soaring corporate borrowing, a high-risk model that needs to be replaced by the kind of free-market measures and budget cuts that fed Russia’s growth in the aftermath of the country’s default and subsequent 44% monthly tumble in the Micex Index, Smith said.

There is potential for a debt trap in industrial companies which can trigger an economy-wide financial crisis as early as next year, Smith said in an interview from London on 12 December, a day after he issued a report predicting China’s slowdown will lead to a 10% decline in emerging-market stocks next year. “If I am wrong on China, I am wrong on everything.”