Nations Awash in Debt: Fragile to Global Shocks

When a country’s total debt, public plus private, approaches 250% of GDP, financial crises seem to take root.  This was the case  for Japan in 1989, the United States in 2007, and for many European countries in 2009 (Figures 1-4).  China and Hong Kong, Australia, Canada, Singapore, South Korea and a number of other countries have now chalked up similar levels of debt relative to the size of their economies.

When debt levels are low, governments, households, and corporations can  live beyond their means by borrowing money. Debt-fueled spending in excess of income expands GDP as spending by one is income for another. As debt levels rise, however, the nature of borrowing changes.  At higher levels of debt, more money goes toward refinancing existing debt instead of spending.  In turn, growth slows.  When total debt levels become too high, either borrower or lender eventually becomes nervous and turns  off the tap, causing a loss of confidence.  This then threatens to send the debt-fueled economic expansion into a reverse spiral.

Figure 1: Japan’s Crisis Began in 1990 When Total Debt Rose to About 275% of GDP from 190% in 1980.

Figure 2. The U.S. Financial Crisis Began in 2007 When Total Debt had Risen to Around 230% of GDP.

Figure 3: Europe’s Financial Crisis Began in 2009 When Total Debt/GDP Surpassed 230%.

Figure 4: U.K. Debt Levels were Around 225% of GDP When NatWest Failed in September 2007.

When people discuss debt-to-GDP ratios, they tend to focus almost exclusively on public debt.  This can be a mistake.  In most countries, public sector debt is only a small portion of overall debt.  However, financial crises occasionally result from excessive levels of public sector debt.  Greece is an excellent case in point (Figure 5). More often, crises emerge in the private sector, as was the case in Japan in the early 1990s and the U.S. in 2007.  Crises can even emerge from the private sectors of countries with very low levels of public debt as was the case for Ireland and Spain in 2009 (Figures 6 and 7).  The crisis in both Spain and Ireland began when their total debt was in the vicinity of 240%-250% of GDP, with public debt below 30% of GDP.

Crises can and do happen at much lower levels of total debt.  This was the case in the late 1980s in the United States with the Savings & Loan debacle, which  took place after a leveraging phase between 1981 and 1987 (Figure 2) that was accompanied by high real interest rates and a sharp slowdown in U.S. nominal GDP growth.

The Asian Crisis in 1997 and 1998 occurred in nations that had debt levels ranging from 60%-150% of GDP.  The difference though is that these countries  had borrowed money in foreign currencies (mainly in U.S. dollars) and when their currencies collapsed, their debts, viewed from a local currency perspective, soared.  This was also the case in Argentina in the early 2000s (Figure 8).

Figure 5: Greece: A Rare Case of Excessive Public Sector Debt Triggering a Crisis. Greek Debt is Still Unsustainable.

Figure 6: Ireland’s Financial Crisis Began With Very Low Public and Massive Private Debts.

Figure 7: Spain also Began its Crisis With Low Government and Huge Private Sector Debts.

Figure 8: Borrowing in Foreign Currencies is, Generally Speaking, a Really Bad Plan.

Our focus here, though, is not emerging market crises that result from an explosive cocktail of foreign currency borrowing and domestic currency devaluation.  Rather, its  countries which have chalked up  excessive levels of debt by borrowing (mostly) in their own currencies. 

Meet the new members of the 250% total debt-to-GDP club: the next candidates for financial crisis?

One might have thought that countries around the world would have learned from the experience of Japan, the U.S. and Europe about the dangers of excessive leverage.  However, this  doesn’t appear to be the case.  Just as the U.S. and Europe spent much of the 1990s and 2000s lecturing Japan while repeating Japan’s mistakes themselves, a number of countries appear to have levered up dangerously in the wake of the American and European financial crises.  These countries include Australia, Canada, China (and Hong Kong), Norway, Singapore, South Korea, Sweden and Switzerland.  Meanwhile within the euro zone, some countries like Ireland, Spain and Portugal are beginning to reduce their debt levels, while others like Belgium, France, Finland, Italy and the Netherlands are seeing debt levels grow.  Countries that have achieved high levels of leverage recently may be at a heightened risk of suffering a major financial crisis during the next several years, although the timing of any such crisis is difficult to determine.

Of these countries, China is of the greatest concern.  Its GDP has grown to over $10 trillion, roughly five times as large as its fellow  BRIC economies of Brazil, India and Russia, taken individually, but still smaller than the U.S. or the European Union.  If China experiences a major financial crisis, commodity prices could spiral even lower.  Ominously, China’s total debt adds up to 249% of GDP, composed of a small public debt (44% of GDP), a modest household debt (39%) and a crushing corporate debt of 166%.  These numbers are reminiscent of the U.S. and the U.K. in 2007, and Ireland and Spain in 2009, but with less household debt and more non-financial corporate debt (Figure 9).  In 2009, with the world in a recession and exports under threat, China extended a great deal of credit to Chinese corporations.  This, combined with a rebound in the world economy, bought China several more years of solid growth.  But deceleration has set in now.  China is also burdened by an overvalued currency and a crackdown on corruption, which may yield long-term gains but comes at a price in the short term.  

Figure 9: From the U.S. Financial Crisis, China Learned to Leverage its Private Sector. Debt=249% of GDP.

The Chinese government is doing what it can to offset the economic slowdown before it becomes a full blown crisis.  The People’s Bank of China is lowering the reserve requirement ratio for banks and cutting interest rates.  The Chinese government is considering a more expansionary fiscal policy.  These moves will likely be helpful but might not be enough to contain serious downside risks.  The U.S., Europe and Japan all increased public sector debt in order to absorb the impact of a private sector deleveraging, with mixed results.  When debt levels become too high, interest rates essentially have to fall towards zero in order for the debt to be financed without creating massive defaults and a debt-deflation depression like the one that the world experienced during the 1930s.

Despite all of these considerable risks, we are not forecasting a hard-landing in China, just a bumpy ride as economic growth continues to decelerate.   The point is, though, that China and many other countries discussed in this report, are now in the debt zone where their economies are much more fragile and less able to withstand global shocks than they would be at lower debt levels. 

China is hardly alone in repeating the mistakes of the Europeans,  Americans and  Japanese.  One might reasonably ask if we are headed into a new Asian crisis, but one fueled not by borrowing in foreign currencies as was the case in 1997-1998 but rather one triggered  by excessive leverage in domestic currencies.  Look at Hong Kong, Malaysia, Singapore and South Korea (Figures 10-13).

Figure 10: Hong Kong: The Ireland of Asia? HK has Massive Private Sector and Little Public Sector Debt.

Figure 11: Malaysia’s Total Debt Isn’t Quite 200% of GDP But Still High by Malaysian Standards.

Figure 12: Congrats to Singapore! The Latest Entrant to the 250% Total Debt Club.

Figure 13: South Korea’s Debt Was 235% of GDP in Q3 2015, Close to Pre-Crisis U.S. Levels.

Certain commodity-producing countries like Australia and Canada have also seen soaring debt levels (Figures 14 and 15) and may be more susceptible to financial meltdowns than in the past.

Figure 14: Australia, Largely Escaped the Crisis in 2008 When Debt Totaled Less Than 200%. Its Debt is Now 239% of GDP.

Figure 15: A Lot of Debt Can Pile Up in the Great White North: Total Debt = 279% of GDP.

Figure 16: Pourquoi Pas? France Levers Up as Many European Peers Cut Leverage. Debt = 278% of GDP.

Figure 17: Finland Follows France Into Massive Levels of Leverage. Total Debt = 308% of GDP.

While Ireland, Portugal and Spain have used fiscal austerity and low ECB rates to deleverage, French borrowers, perhaps encouraged by the ECB’s easy policy, have continued to lever up.

France, whose debt was “only” 214% of GDP in 2007 compared to its current 278% of GDP (Figure 16),  will likely be OK for a while  thanks to the ECB’s ultra-easy monetary policy.  The same can be said for Italy, whose total debt burden has grown from 214% of GDP in 2007 to 257% in 2015 (Figure 18). Finland, too, should be able to support its 308% of GDP debt level (Figure 17).  The problem for the euro zone is that the ECB will likely have to keep rates very low indefinitely until the major  economies deleverage.

Figure 18: Italy’s Debt Burden Not a Risk Until One Day Mario Draghi and the ECB Decide to Stop Printing Money.

Norway and Sweden, like Ireland and Spain in 2009, also have colossal private sector debt but rather modest public sector debt (Figures 19 and 20).  Swedish banks, like their euro zone and Japanese counterparts, actually deposit money at the central bank at negative interest rates.  Negative rates are meant to encourage banks to lend more money rather than hoard cash by depositing it at the central bank.  Is more lending really what an overleveraged economy needs?  In any case, negative rates in Europe and Japan don’t appear to be achieving beneficial results. They haven’t even weakened the Euro,  Kroner or Yen versus the Dollar.  As such, one can’t even claim that negative rates will boost inflation and nominal GDP growth by raising the prices of imported goods and making exports more competitive.  In the end, negative rates at central banks may just be a way of taxing the banking system.

Meanwhile, the Netherlands and Belgium have been following the trajectory of France and Italy towards higher levels of leverage, perhaps encouraged by the ECB’s Quantitative Easing and low-rates policy (Figures 21 and 22).

Figure 19: Norway Should be OK as a Result of Massive Currency Reserves.

Figure 20: Will the Riksbank’s Experiment With Negative Rates Help De-lever or Encourage Borrowing?

Figure 21: The New “Dutch Disease”: A Mountain of Debt Made Feasible Only by Low Rates.

Figure 22: Belgium’s Slow Growing Pile of Debt Totals More Than 300% of GDP.

What Happens After Excessive Levels of Debt Spark a Crisis?

This should be a fairly easy question to answer because Western Europe, the United States, and Japan are currently experiencing this. Nevertheless, we have four insights:

  1. Deleveraging doesn’t necessarily occur and, debt levels mostly continue to rise.
  2. Positive nominal GDP growth is a requirement for any deleveraging.
  3. Solid growth in nominal GDP can be difficult to generate even with an easy monetary policy.
  4. Interest rates stay low for a long time by necessity.
  5. Economic growth is slow.

A crisis doesn’t always (or even usually) reduce leverage.  Japan’s leverage soared after its crisis began in 1990 and now totals 387% of GDP, about 110% more than when its crisis began (Figure 1).  Debt levels soared in U.S., the U.K. and the euro zone, especially in Ireland and Spain, during the early years of their financial crises as well.  The common denominator is negative growth in nominal GDP.  In 2008 and 2009, U.S. GDP actually contracted in nominal terms. Similarly, in most European countries, including Ireland, Spain and Portugal, nominal GDP contracted on and off between 2008 and 2012 as it has in Japan for much of the past two decades (Figures 23-26).  Negative or zero growth in nominal GDP, the denominator in the debt to GDP equation, makes it nearly impossible to stabilize debt-to-GDP ratios much less to actually deleverage.  For example, if total debt is 300% of GDP, and nominal GDP falls by 10%, as happened in Japan between 1997 and 2012, it expands the debt-to-GDP ratio by 30% even if the total outstanding debt stays unchanged.

Figure 23: Japan’s Nominal GDP has Grown only 1% Since 1994: Nowhere Near Enough to De-Lever.

Figure 24: Greece Won’t De-Lever Until Nominal GDP Grows Like in Ireland, Portugal & Spain.

The U.S. and the euro zone have experienced no deleveraging at all since total debt levels stabilized in 2010.  That is because their modest deleveraging of private sector debt was offset by an increase in public sector debt.  In the U.S., for instance, household debt has fallen from 98% of GDP to 79% while corporate debt fell from 73% of GDP in 2008 to 66% in 2012 before drifting back up to 71% by Q3 2015.  Meanwhile, public sector debt rose from 60% of GDP at the end of 2007 to a peak of 103% of GDP in 2013 before tapering off to 98% by the end of 2015.

High U.S. debt levels will make it very challenging for the U.S. Federal Reserve to raise rates as much as it would like to.  The ECB has cut deposit rates to negative levels in an effort to help Europe achieve positive economic growth.  When it comes to excessive debt though, Japan was the canary in the coal mine.  The country’s rates hit zero by 1998 (they should have gone to zero much sooner than that) and have spent nearly two decades at low levels.  U.S. and Western European rates could remain low for another decade or more, with Australia, China and South Korea  soon joining them.

There are exceptions to the excessive levels of debt.  German debt is still below 200% of GDP (Figure 25).  Indonesia  and Saudi Arabia have low levels of debt and used the period of high commodity prices to de-lever their economies (Figures 26 and 27).  Israel has also steadily delivered (Figure 28). Nevertheless, given that low commodity prices are taking a toll on these economies, the world can’t look at these nations for growth. Brazil’s and Russia’s debt levels are high given that they have 10%+ interest rates (Figures 29 and 30).  Among the BRICS, only India looks healthy (Figure 31).

Figure 25: Germany is Europe’s Least Indebted “Good Student” But It Lent Money to Everyone.

Figure 26: Indonesia is a Rare Pacific Rim Country that has Learned from Debt Crises, Its Own and Others.

Figure 27: Saudi’s Paid Down Debt During the Years of High Oil Prices and Have Ample Room to Lever Up.

Figure 28: Israel has been deleveraging.

Figure 29: Brazil’s Debt is High for a Country With 10%+ Interest Rates. Moreover it Continues to Rise.

Figure 30: Russia De-Levered from 1998-08 but Then Re-Levered. Debt Levels are High for 10%+ Rates.

Figure 31: Among BRICS, India is The Only One With a Reasonable Level of Debt Relative to Rates.

Bottom line

  • Australia, Canada, China, Hong Kong, Norway, Singapore and Sweden have achieved levels of leverage consistent with the levels at which Japan, the United States and Western Europe entered into financial crises: around 225-275% of GDP.
  • Low interest rates in some of these nations above (notably Canada, Singapore and the Scandinavian countries) could forestall the onset of a financial crisis as could monetary easing and fiscal stimulus in China.
  • The U.S. has not de-levered in the wake of the crisis, with a rise in public sector debt offsetting a modest decline in private sector debt.
  • The same has occurred within the euro zone.  Some euro zone nations, including Ireland, Portugal and Spain, have begun to reduce leverage, but total debt as a percentage of GDP has been climbing in France, Italy and the Benelux countries.
  • Japan never de-leveraged in the wake of its crisis.  Abenomics is trying to generate faster growth in nominal GDP, a necessary prerequisite to deleveraging.
  • In the face of high levels of debt, interest rates are likely to remain low in the U.S., Europe and Japan for many years, and  countries like Australia, China and South Korea could soon join the (near) zero-rate club.
  • Generally high levels of debt in China, Japan, South Korea and Western countries, portend potentially slow global economic growth which could make equity returns lackluster and put further downward pressure on commodities, notwithstanding their recent bounce.
  • Brazil and Russia have reasonably high levels of debt given how high their interest rates are. Crisis can happen at much lower levels of leverage in countries that borrow in foreign currencies.
  • India’s level of total debt is the only one among the BRICS that looks reasonable compared to the level of rates: another reason to be optimistic about India’s near-term economic prospects.
  • Extremely low interest rates could encourage another increase in total debt as a percentage of GDP but this might add little to growth if new debt is used mainly to finance the existing debt burden.
  • Look to nominal growth rates (real growth + inflation) to see if deleveraging can take place. The recent collapse in commodity prices appears to be making it more difficult for the world to de-lever.


All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only.  The views in this report reflect solely those of the authors and not necessarily those of CME Group or its affiliated institutions.  This report and the information herein should not be considered investment advice or the results of actual market experience.

About the Author

Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.

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