The world isn't 'drowning in debt' even though there's more of it than ever before

Cardboard boat pool water floatOffutt Air Force Base/FlickrU.S. Air Force Senior Airman Stephanie Warner and Staff Sgt. Own Hurley, from the 55th Contracting Squadron, navigate their cardboard boat along the indoor pool located in the Offutt Air Force Base Field House, Neb., Nov. 4.

There’s a lot of debt around the world. In fact, a record amount.

This may be a cause for concern for some. Market watchers of all persuasions — from the perma-bears to the über-bulls — have mentioned that debt accumulation is something to keep an eye on.

Michael Pearce, global economist at Capital Economics, said that while the amount of debt is notable, it isn’t at a point where it will cause a major problem for the global economy.

“However, the assertion that the world as a whole is drowning in debt is too sweeping,” wrote Pearce in a note to clients on Thursday.

While debt is rising, Pearce said, the more important thing is that the groups that owe the debt have an improving ability to pay down that debt due to incredibly low interest rates.

“The decline in real interest rates since the financial crisis means the global economy can sustain higher debt burdens than in the past,” said Pearce. “It is increasingly clear that the fall in interest rates is a structural change, due to factors such as population ageing and a slowdown in global productivity growth.”

Pearce splits the debt burdens into two areas: developing and advanced economies.

In developing economies the debt issue is more worrying as the future income and ability to pay debt down is not as certain. Additionally, the growth of debt in these economies is much faster than in the advanced world.

Thankfully, said Pearce, a number of reforms have allowed these economies to safeguard against sweeping defaults and even if a few of these economies experience problems, they should not infect the rest of the global economy.

“Accordingly, we think fears of a widespread and damaging emerging market debt crisis similar to those seen during the 1980s and 1990s are overdone,” said Pearce. “The more likely outcome is a prolonged period of weak growth as the private sector de-leverages and the legacy of bad loans weighs on potential growth.”

In advanced economies, Pearce said that while public debt is increasing these countries, they are well-capitalised and the likelihood of defaults is low. On the household side, advanced economies actually look better than they have in a decade.

“The most indebted households, notably those in the US and UK, have cut debt significantly and low interest rates have reduced the cost of servicing the remaining debt to multi-year lows,” said the note, adding that US household debt as a share of income is at its lowest since 2002.

“Rising household debt is a concern in a handful of economies, including Australia and Canada. But they are too small to pose a systemic risk to the rest of the world.”

Thus, with a better ability to pay down the debt that is outstanding and deleveraging happening in certain households it appears that debt may be a giant in the economy, but not a dangerous one.

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