A Decade of Debt and Default

The last few years seem like a lifetime in and of themselves. Unlike previous economic downturns, most of which spanned a year or two at most, we're still slogging through the mess left by a decade of excesses in the financial and housing sectors.

Have we made any progress?
Figuring out where we're at in the process of recovery is one of the most difficult tasks that analysts and economists face nowadays. Has the housing market finally hit bottom? Are the improvements in the employment figures sustainable? Are financial institutions out of the woods yet?

To complicate matters further, the crisis was and remains truly global in scale, spawning a whole new category of questions. Will Europe remain a single political and monetary unit as countries like Ireland, Portugal, and Greece yearn for weaker currencies to ignite recoveries? Will China's real estate and export corrections turn into crises of their own?


While these issues continue to dominate the financial news and economists' minds, at the end of the day, the solution to the problem is as simple as it is painful. The world must deleverage -- the nasty process of lowering excessive debt after a credit bubble. And it is here that we must look to measure our progress.

Gauging the progress we've made
At the end of January, the McKinsey Global Institute, an arm of the prestigious management consulting firm McKinsey & Co., published an update to its invaluable research on deleveraging. For those of you interested in this topic, I strongly recommend checking it out.

What's clear from the report is that we still have a long way to go in this regard. Indeed, a full two years after the crisis, most of the world's major economies have only just begun the painful process. In fact, in only three of the largest mature economies -- the United States, Australia, and South Korea -- has the ratio of total debt relative to GDP fallen.

Below is a table with data from the report illustrating the debt composition of the 10 largest mature economies. The debt of each component is expressed as a percentage of GDP. For example, Japan's private debt is equal to 67% of GDP, its nonfinancial companies hold debt equivalent to 99% of its GDP, and so on. All told, the island nation's cumulative debt burden is equal to a staggering 512% of its GDP.

Country

Household Debt

Nonfinancial Corp. Debt

Financial Industry Debt

Government Debt

Total

Japan 67% 99% 120% 226% 512%
United Kingdom 98% 109% 219% 81% 507%
Spain 82% 134% 76% 71% 363%
France 48% 111% 97% 90% 346%
South Korea 81% 107% 93% 33% 314%
Italy 45% 82% 76% 111% 314%
United States 87% 72% 40% 80% 279%
Germany 60% 49% 87% 83% 278%
Australia 105% 59% 91% 21% 277%
Canada 91% 53% 63% 69% 276%

Source: McKinsey Global Institute, Debt and Deleveraging: Uneven Progress on the Path to Growth.

Debt will define our times
Although it's impossible to predict what the endgame will be in this regard, there's little doubt that these obligations will be a defining characteristic of our era. The 1920s were the Roaring '20s. The 1930s were lost to the Great Depression. The 1940s and '50s reaped the economic benefits sowed by war. And so on. The 2010s are set to be known as something like the decade of debt and/or default.

Indeed, which countries default and how they do so will not only dictate history, but also fortunes. For example, if Greece were to default again (as I and others suspect it will) and depart from the euro's monetary union to deal with its fiscal and economic issues, it wouldn't be hard to imagine how companies like Greek shipping giant DryShips (NAS: DRYS) and the National Bank of Greece (NYS: NBG) would suffer from the reinstitution of the drachma and a collapse in international financing. And not to belabor the point, but the same can be said about a company like the Bank of Ireland (NYS: IRE) , as its namesake country is struggling to extricate itself from a cumulative public and private debt burden equivalent to 663% of its GDP.

Yet investors who navigate these times wisely will be rewarded handsomely. The recent performance of the financial sector in the United States provides a case in point. Last year, Bank of America (NYS: BAC) and Citigroup (NYS: C) were two of the most beaten-down stocks of the S&P 500, as investors feared the extent of their liability for fraudulent practices in the mortgage industry. This year, however, they're both flying high. For the year, Bank of America is the top-performing stock on the Dow Jones Industrial Average, up a ridiculous 76%, and Citigroup is up a lesser but still impressive 41%.

Hedging your bets either way
At the end of the day, it's pointless trying to hide from these global trends. A better alternative is to invest in strong companies that are both growing and globally diversified. It's for this reason, in turn, that our analysts recently published a free report about three American companies that are dominating the world and making their shareholders rich at the same time. To learn the identity of these companies while the report is still available, click here now -- it's free.

At the time this article was published Fool contributor John Maxfield owns shares in Bank of America. The Motley Fool owns shares of Bank of America, Citigroup, and Bank of Ireland. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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kramdenrf

Decent article. 35 years ago Jimmy Carter warned the USA that private debt represented a bigger threat than public debt, and from those numbers, it appears he was right about that, as he was about nearly everything else. Public debt can easily be brought under control by a return to sane tax policy (i.e. repealing the dubya AND raygun tax cuts for the rich,) and cutting military spending down to 2000 levels or below - but private debt is another matter entirely. That would require a major shift in both attitude and in perception. It doesn't help that inflation is a 100% total correlation response to growth in the USA (and always has been, the idiocy of reverting to the gold standard or anything like it is just that.) Or that the "business" media has been harumphing that inflation is already disastrous and going to get much worse - a purely political ploy at best and an outright lie at worst - to scare people into buying stuff on credit now instead of saving at least a larger portion of the cost before purchasing.

April 02 2012 at 11:41 PM Report abuse rate up rate down Reply
donut999

Good article and info. We all need to head for the hills if this bubble bursts.

March 30 2012 at 8:43 AM Report abuse rate up rate down Reply