Will Global Debt Boost Gold?

A global debt time bomb is ticking. What does it mean for the global economy and the gold market?

Global Debt Rising

Eight years after the burst of a global credit bubble resulted in the worst financial crisis since the Great Depression, debt continues to grow. Instead of reducing indebtedness, or deleveraging, all major economies today are more indebted than in 2007. McKinsey found that between 2007 and mid-2014 global debt had increased by $57 trillion, increasing the total debt as a percentage of global GDP by 17 percentage points to 286 percent. It is definitely higher today. Total public and private debt is at all-time highs and amounts to 185 percent of GDP in emerging markets and 265 percent of GDP in the OECD countries, in both cases 35 percent higher than it was during the onset of the financial crisis. As William White, the Swiss-based chairman of the OECD's review committee and former chief economist of the Bank for International Settlements, pointed out: “debts have continued to build up over the last eight years and they have reached such levels in every part of the world that they have become a potent cause of mischief”.

Why Will the Next Crisis Be Much Worse than the Great Recession?

The current level of global debt is unstable and poses great risks to financial stability. It is probably the greatest economic and social challenge of our times since many of the current debts will never be serviced or repaid. It means that some people will stay with worthless assets (unless they have gold which has no credit risk). The global economy is saturated with debt, which explains the current slowdown of economic activity. The debt overhang among households typically leads to deeper recession, slower recoveries, and lower financial stability.

The debt bomb will explode one day and it could be much worse than during the Great Recession. Why? First, global debt is higher than in 2007-2008. Second, central banks are out of ammunition. They are helpless and the introduction of negative interest rates is the best evidence proving that. Moreover, they face a true tragic dilemma. If they raise rates, the results may be awful (maybe the timing of the current market turmoil just after the Fed’s hike is not accidental), but if they do not raise rates, the unsustainable debt bubble will become only bigger and more dangerous in the future.

Third, the emerging markets are also seriously indebted. During the Great Recession, they were part of the solution and supported global growth. Now, they are part of the problem, especially China, which accounts for about half the debt in emerging markets. The combined Chinese debt rose from about 160 percent in 2008 to more than 240 percent in 2015. The current Chinese slowdown is the very result of the unwinding of the debt bubble. It poses a real threat to the global economy since China accounts for 34 percent of global growth.

Conclusions

Summing up, total debt as a percentage of global GDP has risen to an unsustainable level since the Great Recession. This poses serious risks for financial stability, given that central banks are helpless and emerging markets will not carry the burden of debt this time. What are the implications for the gold market? The unwinding of global debt will be fundamentally supportive for the price of gold. The global economy will either stagnate and fall into the trap of debt-deflation, which would decrease real interest rates and make gold look more attractive compared to other assets, or plunge into another financial crisis. In this case, safe-haven assets would rise. When the confidence in the global economy decreases, gold shines.