The McKinsey Global Institute released a new study examining the growing world debt and warns of increased risks to worldwide financial stability.
According to the report, total world debt — including government, household, financial, and corporate — increased to $199 trillion in 2014. This is almost three times the total yearly world output.
Since the Great Recession (beginning in 2007), global debt has increased by $57 trillion, far outpacing the world’s economic growth in composite GDP.
Only 5 countries have lowered their total debt burden: Argentina, Romania, Egypt, Saudi Arabia, and Israel.
It’s Not Just Governments
While government debt is expanding at the fastest pace worldwide, all sectors have significantly increased their debt burdens.
Probably the most remarkable retreat was from the financial sector, significantly deleveraging after the U.S. mortgage-lending crisis of 2007-2010.
Household debt, according to the report, is a worldwide ticking time bomb. The lessons were not learned from the U.S. financial crisis, and levels of unsustainable debt continue to soar.
Of the industrial nations, only the United States, Ireland, Portugal, Spain, and the United Kingdom have seen significant slowing in the accumulation of household debt.
In particular, the household debts in the Netherlands, South Korea, Canada, Sweden, Australia, Malaysia, and Thailand are seen by analysts as unsustainable and in jeopardy of non-repayment.
Is China Set Up For Its First Widespread Financial Collapse?
In America, we generally see China as a buyer of debt, not as a country accumulating an unsustainable debt burden.
China has had an impressive period of expansion, and too often the delusion of “never-ending growth” becomes contagious.Total world debt -- government, household, financial, and corporate -- increased to $199 trillion in 2014.
One-third of the world’s $57 trillion debt increase was from China’s debt explosion, with total debt exceeding 282 percent of GDP (higher than the United States).
Some of this debt seems almost foolish, with municipalities accumulating $1.7 trillion in debt solely on purchasing automobiles for government use.
But two looming risks are the cause of the analyst’s alarm: the level of debt tied to real estate and the rapid increase of shadow banking.
Both of these risks were fundamental causes of the U.S. banking crisis, but China’s leveraging is even worse. Over half of the total debt in China is in debt linked to real estate.
Shadow banking is the term that describes nontraditional banking institutions. These entities are often unregulated and uninsured, and frequently take extraordinary risks.
Shadow banking in China is increasing at 36 percent per year, trying to keep up with the ever increasing demand for finance.
While there is nothing inherently wrong with shadow banking (it exists in the United States as well), at these levels it adds unnecessary risk and instability to the entire financial system.
Are We Heading Toward a Worldwide Financial Meltdown?
Consumption always drives the economy — consumption increases business investment by sending signals for firms to hire and produce more products.
But the world is consuming on borrowed money. What happens when the credit runs out?
As credit runs out, households (the primary consumers) spend less to pay down debt. This, in turn, cools down the economy, businesses layoff workers, and payrolls decrease, which makes it harder to pay down debt or consume.
This is what concerns these analysts. At some point, the world credit supply will run out. And even if it doesn’t, huge portions of GDP will be paid in interest, not in consumption.
Take for instance China’s recent debt explosion. At close to 300 percent of GDP, the total interest on debt (at say 5%) would equal roughly 15 percent of the total GDP.
And there’s the catch-22. We can’t have a sudden retreat from spending with debt. At some point, however, the interest due will consume a huge portion of the total GDP.
We’ve created the perfect storm — and at this point, we’re probably going to have to ride it out when the storm makes landfall.