Will increasing debt load create a problem, eventually?

 

Many countries have been pumping liquidity to revive the economy and mitigate the devastating economic effect of the COVID-19. The end result is that the amount of debt has risen tremendously throughout the world.

 

The graph below how precipitously debt load has grown in the last decade compared to GDP (Debt/GDP).

 

Private debt Source: IMF

 

General government gross debt

Source: IMF

 

The debt load has only become worse, as all of these graphs show. Does this seems like a sustainable economic path?

 

Source: U.S. Office of Management and Budget and Federal Reserve Bank of St. Louis, Federal Debt: Total Public Debt as Percent of Gross Domestic Product [GFDEGDQ188S], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/GFDEGDQ188S, December 15, 2020.

 

To answer this question, we need to look at the numerator (debt) and denominator (GDP) differently. To decrease the debt to GDP ratio, either debt has to go down or GDP has go up. Pumping liquidity into the economy and financial market by issuing more debt has become a norm, and it does not seem likely that such phenomenon would slow down.

 

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Then, the only way to sustain the debt burden is for the economy to continue to grow at a pace faster than the pace at which the debt burden is growing. However, with the world entering into a chronical low economic growth era, this also does not seem viable.

 

Where will all this debt festival lead to?

 

2020 has seen a dramatic drop in GDP, but from 2021 GDP growth is likely to rebound as the governments have been increasing spending and central banks have been pumping money into the economy.

 

My guess is that with the economic growth rebounding, the yields on long term bonds may go up, which will drag down the recovering economy (I wrote this article in 2020, but this is already happening). Because the economic rebound is not necessarily a result of consumers spending more or companies investing more, but rather because governments are spending more, the short term rebound may not be sustainable.

 

Low interest rates may give some breathing room for ever increasing debt to GDP ratio, but unsustainable increase in debt and sluggish GDP growth may eventually create a problem.

 

How will the world respond?

 

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