1qGLG9p

88 Deleveraging, What Deleveraging
A key theme of the report is that the world has continued to leverage up
even as debt repayment capacity has fallen. Repayment capacity in the report is
proxied by the GDP growth rate. It is true that debt has continued to increase – a
little bit in developed economies and a lot in developing economies – but it is
not really obvious that GDP growth rates have fallen. The report emphasises long
spans of nominal GDP growth rates. Since the 1970s, the big decline has been
driven by lower inflation. We do not know whether real GDP growth rates are
going to fall in the future, but we certainly should not extrapolate from the last
few years because the crisis was only really over towards the end of 2012.
The conceptual framework is, to a small degree, a credit risk setup and, to
large degree, a macroeconomic setup. Looking at the economy from a 100,000
foot perspective, it is reasonable to say that the debt burden that society can bear
is a function of GDP growth. If GDP growth goes up then the debt burden goes
down, and if the debt goes up then the debt burden goes up as well. One credit
risk perspective would be a version of Merton’s model of debt: debt capacity is a
function of national value, proxied by the rate of GDP growth, and of volatility
of GDP growth. There is very little in the report regarding volatility. Yet one
feature of the global economy before the crisis was the Great Moderation, during
which the volatility of GDP growth had fallen. In such a world, governments can
lever up more.
Why are things not quite so bad True, debt has gone up, but it is not obvious
that the capacity to pay has gone down. There is no obvious downtrend in world
real GDP growth. One might argue that the decline in inflation over the past
30 years has increased the burden of outstanding debt. However, if you look at
debt in the US, only a small proportion of it is fixed-rate, long-term and noncallable.
Therefore, in a falling inflation environment much debt has been called
or interest rates have been reset, which should have reduced the debt burden as
inflation fell. An exception is US government debt because much of it is fixedrate
and non-callable, but at this point in time, most of what is outstanding has
low or moderate interest rates.
The report observes that some countries, such as Japan and China, appear to
be overleveraged, but they are getting away with it because debt is mostly held
domestically. However, you cannot get away with being overleveraged forever
and when adjustment comes, there will be an impact on the real economy.
It is important to consider trends for the most leveraged sectors, not just
economies as a whole, because the most leveraged sectors harbour much of the
credit risk. At least in the US, much of the deleveraging of the last few years was
in the most leveraged sectors, a point that is not widely recognised even by most
credit risk analysts. The US has a much more stable leverage situation today than
it faced before the crisis, because many of the very highly leveraged entities did
not survive the crisis.
Olivier Ginguené, Pictet Asset Management SA, Geneva
Olivier Ginguené discussed leverage from the point of view of an investor.
He liked that the report is fact-based and found it very relevant for investors.