Clear Warning from the IIF

The Institute of International Finance (IIF) in Washington last week issued a report spelling out clear warnings around record high corporate debt both in the west and emerging markets, each presenting its own cocktail of threats to the global economy.  We summarise the key points as follows:

-  Emerging markets corporate debt has ballooned 5-fold to $25 trillion in the last decade, most of that since the GFC.

-  The west has been on the same binge and the US in particular has seen reckless borrowing to buy back shares and pay dividends despite profits being in decline since 2014.

-  The ratio of net debt to earnings (EBITDA) for US companies has literally doubled to 1.4 from the 0.7 reached at the top of the pre GFC subprime bubble.  In case you missed that, they have borrowed 1.4 times more than they earn…. The cash to debt ratio is just 0.24.

-  Companies have issued $1.9 trillion in junk bonds over the cycle, double that of just pre GFC.  Junk bonds are already under stress with yields spiking to 20% in February (as we explained and reported here) and defaults at the highest level since the GFC.

-  Corporate debt alone is 70% of GDP in the US, 100% in Europe, and 175% in China (the highest in the world).  They estimate China’s total debt to GDP has reached 295% and rising fast.

-  Most of the $25 trillion in company debt is in local currencies.  Whilst that lessens the chance of a ’98 style currency crisis, the Bank for International Settlements (BIS) warns any rate rises by the US Fed could set off an emerging markets crash.  When one considers this against the moribund US ‘recovery’ it paints a very grim picture for a Fed who knows they need to raise rates to bring back some normality  but also know doing so could spark the next, and potentially biggest ever, financial crash.

That’s why Stanley Druckenmiller last week said China was in the midst of an "extremely rare and quite dangerous" explosion of debt and compared the situation with "subprime mania" in the U.S. back in the mid-2000s, adding: "We know how that ended."  No wonder he bought $300m worth of gold last year….