The great wall of debt

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

The writer is managing director at Crossborder Capital and author of ‘Capital Wars: The Rise of Global Liquidity’

If bull markets always climb a wall of worry, then financial crises often smash into a wall of debt. We are already walking into the foothills of another crisis. It is not just the growing size of the interest bill that matters, but more so the task of rolling over a pile of maturing debts. Next year and particularly 2026 will prove challenging years for investors.

Consider how, over the coming months, stock prices will not only have to defy growing investor doubts about growth and inflation, but by late 2025 they will have to scale a sizeable maturity wall of debts. This term describes the bunching in the refinancing of those debts mostly taken out, a few years back, when interest rates were rock bottom. Similar refinancing tensions have helped trigger several past financial meltdowns such as the 1997-98 Asian crisis and the 2008-09 financial crisis.

Tensions arise because debt grows ever upwards whereas liquidity is cyclical. History shows that financial stability requires a near-constant ratio between the stock of debt and the pool of liquidity. Too much debt relative to liquidity threatens refinancing crises as debts mature and cannot be rolled over. At the other extreme, too much liquidity leads to monetary inflation and asset price bubbles. It is important that policymakers steer a middle course.

This is not the standard textbook argument, which still views capital markets primarily as new financing mechanisms for capital spending, whereas, under the current weight of world debt that is estimated by the Institute of International Finance to be $315tn in the first quarter, they have turned into huge debt refinancing systems.

In a world dominated by debt refinancing, the size of the financial sector’s balance sheet capacity matters more than the level of interest rates. Roughly three in every four trades now made through financial markets simply refinance existing borrowings. For illustration, taking an average seven-year maturity, this means that a whopping near $50tn of existing global debt must be rolled over on average each year.

This requires greater financial sector balance sheet capacity. Troublingly, this also demands ever larger volumes of global liquidity to grease the bearings.

It is true that global liquidity — the flow of cash savings and credit through financial markets — has lately been rising strongly. The evidence is in the recent solid gains across riskier asset markets as well as the all-time records set for many stock markets and the gold price. Global liquidity has been fuelled by rising bank lending, underpinned by the improving value of collateral to that supports loans, and by a long list of central banks eager to ease monetary policy. Our latest estimates show a $16.1tn increase in global liquidity over the past 12 months and a more impressive $5.9tn jump since end-June to reach nearly $175tn: a pool roughly 1½ times global GDP. This equates to a seemingly healthy 15 per cent annualised expansion.

Yet, looking ahead, the markets will demand even more liquidity to feed the rapacious appetite of debt. Since 1980, the ratio between advanced world debt and global liquidity has averaged 2.5 times, and in the crisis year 2008 it hit 2.9 times. It went on to peak during the Eurozone banking crisis in 2010-12. By 2027, it is likely to again exceed 2.7 times. More worryingly, by 2026 the maturity wall, which measures the size of the annual debt roll for the advanced economies alone, is likely to jump by nearly a fifth to over $33tn in absolute terms, or three times their annual spend on new capital expenditure.

What can policymakers do to protect investors? In the short term, the answer is to explicitly manage liquidity conditions rather than simply tweak interest rates. This may be unfashionable because it takes us back to the days of the QE (quantitative easing) and QT (quantitative tightening) programmes by central banks to support economies. That runs the risk that overeager central bankers inflate ever larger asset bubbles. Nonetheless, given big and embedded government budget deficits, and given the recent shift, notably by US Treasury secretary Janet Yellen, towards funding these with short-dated bills and Treasury notes, we figure that the pool of global liquidity may need to expand at an annual 8-10 per cent clip. Put another way, at this growth rate its aggregate size will double every eight years.

In the long term, the only solution is to reduce debt. With ageing populations demanding ever larger and often mandatory welfare outlays, this is a big ask for governments. But unless something more is done, the cost of the next bank bailout could make the 2008-09 rescue packages look like the lunch bill.