The current debt situation: misconceptions, status quo and outlook

“Debt is always in the spotlight, but this is broader. We need to set it into perspective.” Christian Gattiker, Head of Research, explains two common misconceptions, analyses the current global debt level and elaborates on the consequences for future generations.

When talking about debt there are usually two common misconceptions: One aspect that people tend to forget is that it is surrounded by assets and balance sheets. Debt is just one side of the balance sheet, but usually everybody focuses on the debt levels.  If debt is backed by assets, especially physical assets, then we are however talking about a completely different ball game. This is the common misconception.

The other misconception concerns the ‘right’ level of debt for which we will never be able to develop an all-encompassing formula. There are economists who claim that an absolute level exists, however this has been proven wrong by empirics. I believe that the assumption of a right level of debt is a misconception.  

The status quo
Global debt has hit an all-time high because there is so much demand for it. There is also a price for issuing debt, which is very attractive. Consequently rates are low which is the reason why this bonanza has been taking place, and probably will continue to some extent.

It was a nice way out of the crisis, particularly during times of recession. Governments and emerging markets issued debt, and there the corporate sector was very eager to step in and take the opportunity of increasing debt. It was like a remedy to the financial crisis which happened ten years ago.

Debt-driven risks
If there are signs of a repetition of 2008 – and this would of course be a devastating experience – they would very much depend on how they are managed, how they evolve, and where will be the centre. Last time it was the US housing market. The likelihood of that happening again is however rather limited, given the restrictions of the US banking system at this stage.

Every debt crisis has its particular characteristics. However, if this turns out to be a global one, and the contagion expands around the world, we would be looking at a very black picture.

Global debt reduction
Ideally, governments would step in when there is a need for economic activity and increase debt in recessions. Then, during boom times, where we are right now, they would reduce their debt levels again. Unfortunately however, politicians like to get re-elected. They therefore tend to issue a lot of debt during recessions and sizeable debt in good times. Consequently the reduction of debt is not happening – which is a burden in the long run.

Consequences for future generations
If the debt situation continues and if it proves to be unsustainable, it will be a heavy burden on the next generation.

There are usually two ways out of it: One is to let inflation take care of it. This means to devalue the debt over a few years, which is a hurtful experience because it erases a lot of purchasing power.

The other possibility, which is hardly any easier, is a straight debt cut – just write it off. This usually also has some heavy consequences: in terms of wealth we speak of immediate effects as well as long-term effects dependent on how we deal with it after the debt cut and how we get the economy back to life.

There is no easy answer to this question, but what is certain is that future generations will be left with the issue of having to resolve what this generation started.

About NZZ Podium
The Neue Zürcher Zeitung’s NZZ Podium is an event series that addresses topics of our time. The event held on 8 February 2018 dealt with the debt-based economy. Julius Baer is a co-sponsor of the panel discussion series.

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