The global financial crisis and the ensuing Great Recession of 2008-2009 that wreaked havoc on the public finances of the major advanced economies is forecast to get even worse in the years ahead. An analysis of the IMF's latest medium-term projections shows that over the 2007-2017 period the level of debt is projected to increase at a faster pace than growth in output in each of the major economies further pushing up the debt-to-GDP ratio.
In the pre-crisis world of 2007, debt ratios ranged from a low of 44% in the UK to a high of 183% in Japan. But, with the level of debt projected to grow faster than their respective economies, the debt-to-GDP ratio is slated to be higher in all G7 nations in 2017 compared to 2007. By 2017, the ratio is expected to range from a low of 74% in Germany to a high of 250% in Japan (see table).
|DROWNING IN DEBT*|
|Trillions||% of GDP|
|* General government gross debt, Source: IMF World Economic Outlook Database (October 2012)|
In nominal terms the total value of goods and services produced is projected to be larger in all the G7 countries in 2017 compared to a decade earlier, but growth rates are expected to vary widely. For instance, the IMF projects that by 2017 Japan's economy will only be 1% larger than it was in 2007 whereas at the other end of the spectrum, Canada's economy will be 44% bigger, the United States' 41% and the United Kingdom at 39%. The major European economies are also projected to grow but at a considerably slower pace. By 2017, France and Germany's economies are both estimated to be 26% larger and Italy's by 12%.
Since 2007, national debt levels have been exploding in all the major advanced economies. By 2017, the level of government debt is expected to more than double in the US, rising from $9.4 trillion dollars in 2007 to $22.5 trillion. The debt outlook for the UK is even more dramatic. That country's national debt is projected to triple and hit £1.8 trillion in 2017, a jump of £1.2 trillion from its 2007 level. Canada's debt level is expected to climb to $1.7 trillion in 2017, up from about $1 trillion in 2007. In France, Germany and Italy, debt levels are projected to top €2 trillion in each country and Japan is expected to tack on another ¥35 trillion in debt.
With public finances that are already at abysmal levels, the projected deterioration in the debt levels of all the major advanced economies will continue to challenge the ability of governments to service their debt. Moreover, governments have been able to borrow at super-low interest rates but once interest rates start to inevitably head back up to more normal levels, the debt servicing costs will soar.
The best way out of the debt trap is via economic growth but, alas, despite letting loose record amounts of monetary and fiscal stimulus, growth has failed to gain traction. Indeed, the latest data shows that GDP is heading down not only in the G7 economies but it is also decelerating sharply globally. The bottom line is that winding down these mountainous debt levels will take a long time and will act as a brake on economic growth.
The writing is on the wall. Faced with a toxic combination of high debt, low growth and a rapidly aging population it is going to be a huge struggle for the G7 economies to nurse their economies back to self-sustaining health and stop the erosion in standards of living which has been underway since 2007. With virtually no room left to maneuver on the macro-policy front, it looks like a long economic winter lies ahead for the advanced economies.
A good way for fixed-income investors to protect themselves against the coming cold front is to be diversified and to put more emphasis on short- and medium-term bond funds. They should reduce their exposure to long-term bond funds as these funds will take the bigger hit when interest rates inevitably reverse course and start to climb.
The following ETFs may be worth a closer look: Vanguard Intermediate-Term Bond ETF (BIV); Vanguard Intermediate-Term Corporate Bond Index ETF (VCIT); and iShares JPMorgan USD Emerging Markets Bond (EMB).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.