In Antifragile, author Nassim Nicholas Taleb makes the argument that when we try to remove disorder from a system and render it predictable we in fact set this system on a course to major shocks and even destruction. This is precisely what has happened to the world economy since the financial crisis. Government responses to the bursting of the credit bubble, which was necessary and inevitable, sought to smooth out short-term shocks and losses. While government intervention is important, the cost of the interventions that staved of the full force of the financial crisis have been tremendously high and significantly underreported. Public debt has taken the place of private debt and the world is drowning in it. 2016 could well be the year that we hit a major shock and return to global recession.
Global debt has ballooned by $57 trillion since the financial crisis. $25 trillion of that increase has come in the form of government debt of which $19 trillion came from major economies. According to a recent McKinsey report, all major economies are deeper in debt today than they were in 2007. A sizeable body of academic literature has linked high debt to slower GDP growth and increased risk of financial crisis. Picture a swimmer trying to reach the surface with his foot tied to a fast sinking 50 pound rock. The world economy is that swimmer, and the rock is world debt.
China — whose economic slowdown is the issue of the hour — remains particularly vulnerable. China’s total debt quadrupled from $7 trillion in 2007 to $28 trillion by mid-2014. This was spurred by massive government stimulus for infrastructure and other projects during the financial crisis. This stimulus flooded the market with excess capacity such as entire cities without a single resident. Indeed, Mckinsey estimates that $9 trillion of China’s debt is related just to real estate. With high private and public debt as well as troubling economic fundamentals China’s economy is setting off alarm bells worldwide.
The Eurozone continues to suffer serious woes. The structural weaknesses that sparked the Eurozone crisis remain unsolved, despite recovery in some of the peripheral economies most notably Spain and Ireland. The launch of a €1.1 trillion quantitative easing program by the ECB in 2015 is a sign of how deep these weaknesses go. This has been compounded with the demographic pressures of shrinking, aging populations. While the refugee crisis could alleviate these issues in the form of new, young workers the political response to this potential economic boon has been less than friendly.
The US is also vulnerable to the risks of high debt. Since the crisis US debt-to-GDP has risen from a reasonable 76% to a more significant 101%. Moreover, forecasts have the debt-to-GDP ratio holding at 100% of GDP well into 2020. This means that US GDP growth is not forecast to outpace debt growth. Indeed, the US’s disappointing fourth quarter growth last year of only 0.7% indicates that growth is failing to take off as was predicted a few years ago. Additionally, US labor force participation is hovering at 40-year lows, down from 66% in 2007 to 62.6% in 2015.
Aside from the size of the debt, the nature of the debt is particularly worrying. There are signs that student debt, currently amounting to $1.2 trillion, is falling into the same trap that subprime mortgages did. To put the issue in context more than two-thirds of US students graduate with debt and this debt averages to $35,000 per student. Student debt passed two worrying milestones when it surpassed credit card debt in 2010 and auto loans in 2011. But most worryingly 16 million people borrowed money from the Federal government to attend school. At the peak of the real estate bubble there were only 6 million subprime borrowers. Many cannot afford to pay back these loans but unlike a subprime borrower you can’t sell your degree and get out of the mortgage, you have to pay back every cent.
On a different front, data on the business cycle makes the case that we are in for a downturn sometime in the next 18 months. US economic expansions have lasted for an average of 5 years (60 months) in the post-WWII period. The current expansion has lasted 78 months and we are overdue for a downturn sometime soon. This is reinforced by a recent Investopedia article which highlighted how current economic data is looking surprisingly similar to the data leading up to the previous recession.
Thus, all the actions by central banks and governments worldwide staved off short-term shocks in 2008 but in doing so they prevented the market from self-correcting. In the meantime the world’s debt burden has grown tremendously and countries are increasingly struggling to stay afloat. A free market is bound to self-correct and 2016 looks good to be the first year of a long overdue market correction.
In conclusion, by trying to stave off the short-term shocks of the financial crisis, central banks and governments have set the world economy on a collision course with debt. Increasingly countries are struggling to stay afloat, weighed down by ever increasing debt. The trillions of dollars needed to bail out banks, households and everyone in between had to be paid for somehow. 2016 looks likely to be the year we find out who.
Originally published at www.northeastern.edu on January 31, 2016.