National Debt and Rates of Return

Over the past few weeks it has been clear that another exploration of deflationary risk is in order. Having already published Inflation vs. Deflation (3-15-10) and Avoiding Global Deflation (7-18-10), as well as The China Bubble (6-8-10) there seemed no point in compiling additional alarming, but anecdotal information. Nothing has changed. Debt is too high almost everywhere, certainly in the U.S. and the Eurozone, and even if Chinese debt ratios appear low, the information available could be misleading because China’s banking system is opaque, and much of their collateral may be grossly overvalued.

Because for the past thirty years the global economy has relied on rising debt to fuel rapid economic growth, as debt levels become unsustainable, economic growth slows. When that occurs, asset values drop, meaning that outstanding loans are no longer backed by sufficient collateral. Even in a mildly deflationary environment – which for now, thankfully, is all we are dealing with – real rates of return on large investment funds cannot realistically be projected at levels that cause total interest payments to consume an inordinate percentage of GDP. The more debt exists as a percentage of GDP, the more a burden interest payments become, and the more imperative it becomes to keep interest rates low to maintain solvency – whether that is solvency of government, business, or household entities.

As an aside, when considering levels of debt, what level is deemed sustainable will affect the […] Read More