World Debt as % of GDP

As inflation peaked in 1980 and interest rates started to decline globally, the debt to GDP ratios began to increase. Globalisation was a major disinflationary force allowing central banks to cut interest rates despite rising debt ratios. After the 2008 financial crisis, the growth in government debt took over as the driver of the credit cycle. If all this debt growth over the last 40-years ended in the real economy, it would have fuelled real economic growth, but a substantial portion of this ended up in financial assets explaining why assets outperformed the real economy. This asset inflation is now detrimental for the real economy as asset inflation is luring savings away from the real economy. Asset prices are supposed to be a consequence of the underlying economy but have become the driver through the wealth effect.


US GDP and 10yr bond rate.



The rising debt over the last 40-years, however, became a drag on economic growth in the developed economies. The developed world central banks, especially the Fed, supported the economy with lower interest rates and more liquidity during every economic slow-down or time of financial distress. These measures did support the recovery, but these economies never returned to the growth numbers before the financial distress. The emerging markets have been the driver of global growth since the early 1990s, but the debt growth in the emerging markets, especially China since the GFC, leaves the EMs in a similar debt position as the developed economies.

The global economy exploded higher with the monetary and fiscal policy stimulus during the pandemic, and the global stimulus was nearly a third of the global economy, explaining the sharp recovery and the current inflationary pressures. Many believe that this rising inflation rate is a return to the 1970s.

As long as the USD is the reserve currency and the US remains the biggest consumer of global goods, it is essential to understand the US monetary and fiscal policies. In 2018 the Fed also had the best intentions to normalise interest rates, but by December 2018, the stock market came under pressure, and the Fed had to reverse its policy. We expect a similar situation to develop later this year as the tighter liquidity conditions and higher funding costs start to take their toll on the US and global economy. China is also not positioned to stimulate as before as it must restructure the debt in the property sector.

The question is not whether the tighter financial conditions would derail the economy and the risk-on phase in the markets, but rather at what rate. If history repeats itself, it would be at lower levels than in 2018.