A Decade of Debt and Default

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The last few years seem like a lifetime in and of themselves. Unlike previous economic downturns, most of which spanned a year or two at most, we're still slogging through the mess left by a decade of excesses in the financial and housing sectors.

Have we made any progress?
Figuring out where we're at in the process of recovery is one of the most difficult tasks that analysts and economists face nowadays. Has the housing market finally hit bottom? Are the improvements in the employment figures sustainable? Are financial institutions out of the woods yet?

To complicate matters further, the crisis was and remains truly global in scale, spawning a whole new category of questions. Will Europe remain a single political and monetary unit as countries like Ireland, Portugal, and Greece yearn for weaker currencies to ignite recoveries? Will China's real estate and export corrections turn into crises of their own?

While these issues continue to dominate the financial news and economists' minds, at the end of the day, the solution to the problem is as simple as it is painful. The world must deleverage -- the nasty process of lowering excessive debt after a credit bubble. And it is here that we must look to measure our progress.

Gauging the progress we've made
At the end of January, the McKinsey Global Institute, an arm of the prestigious management consulting firm McKinsey & Co., published an update to its invaluable research on deleveraging. For those of you interested in this topic, I strongly recommend checking it out.

What's clear from the report is that we still have a long way to go in this regard. Indeed, a full two years after the crisis, most of the world's major economies have only just begun the painful process. In fact, in only three of the largest mature economies -- the United States, Australia, and South Korea -- has the ratio of total debt relative to GDP fallen.

Below is a table with data from the report illustrating the debt composition of the 10 largest mature economies. The debt of each component is expressed as a percentage of GDP. For example, Japan's private debt is equal to 67% of GDP, its nonfinancial companies hold debt equivalent to 99% of its GDP, and so on. All told, the island nation's cumulative debt burden is equal to a staggering 512% of its GDP.


Household Debt

Nonfinancial Corp. Debt

Financial Industry Debt

Government Debt


Japan 67% 99% 120% 226% 512%
United Kingdom 98% 109% 219% 81% 507%
Spain 82% 134% 76% 71% 363%
France 48% 111% 97% 90% 346%
South Korea 81% 107% 93% 33% 314%
Italy 45% 82% 76% 111% 314%
United States 87% 72% 40% 80% 279%
Germany 60% 49% 87% 83% 278%
Australia 105% 59% 91% 21% 277%
Canada 91% 53% 63% 69% 276%

Source: McKinsey Global Institute, Debt and Deleveraging: Uneven Progress on the Path to Growth.

Debt will define our times
Although it's impossible to predict what the endgame will be in this regard, there's little doubt that these obligations will be a defining characteristic of our era. The 1920s were the Roaring '20s. The 1930s were lost to the Great Depression. The 1940s and '50s reaped the economic benefits sowed by war. And so on. The 2010s are set to be known as something like the decade of debt and/or default.

Indeed, which countries default and how they do so will not only dictate history, but also fortunes. For example, if Greece were to default again (as I and others suspect it will) and depart from the euro's monetary union to deal with its fiscal and economic issues, it wouldn't be hard to imagine how companies like Greek shipping giant DryShips (Nasdaq: DRYS  ) and the National Bank of Greece (NYSE: NBG  ) would suffer from the reinstitution of the drachma and a collapse in international financing. And not to belabor the point, but the same can be said about a company like the Bank of Ireland (NYSE: IRE  ) , as its namesake country is struggling to extricate itself from a cumulative public and private debt burden equivalent to 663% of its GDP.

Yet investors who navigate these times wisely will be rewarded handsomely. The recent performance of the financial sector in the United States provides a case in point. Last year, Bank of America (NYSE: BAC  ) and Citigroup (NYSE: C  ) were two of the most beaten-down stocks of the S&P 500, as investors feared the extent of their liability for fraudulent practices in the mortgage industry. This year, however, they're both flying high. For the year, Bank of America is the top-performing stock on the Dow Jones Industrial Average, up a ridiculous 76%, and Citigroup is up a lesser but still impressive 41%.

Hedging your bets either way
At the end of the day, it's pointless trying to hide from these global trends. A better alternative is to invest in strong companies that are both growing and globally diversified. It's for this reason, in turn, that our analysts recently published a free report about three American companies that are dominating the world and making their shareholders rich at the same time. To learn the identity of these companies while the report is still available, click here now -- it's free.

Fool contributor John Maxfield owns shares in Bank of America. The Motley Fool owns shares of Bank of America, Citigroup, and Bank of Ireland. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (3) | Recommend This Article (11)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 04, 2012, at 6:45 PM, TrojanFan wrote:

    Switzerland would be another good candidate for inclusion in this table.

  • Report this Comment On April 04, 2012, at 7:04 PM, JohnMaxfield37 wrote:

    I agree. For the sake of space, I limited the table to the 10 largest mature economies.

  • Report this Comment On April 13, 2012, at 6:32 PM, TrojanFan wrote:

    I'm also curious what standard McKinsey used to define a "mature" economy.

    I would say it's certainly open for debate that China should be included in that group, though that would be problematic from a data compilation standpoint for the researchers because that economy is an opaque black box and most of the official data coming out of that country is "massaged" at best or completely fallacious at worst. Once they have to recapitalize their banking system, and that day is coming really soon, those enormous currency reserves that the developed world is so in awe of are going to be depleted at a ferocious rate. They still have to go through their Great Depression like we did here in the 1920s after we industrialized and I don't think they will be able to escape that inevitable fate.

    Including South Korea in the group in the cutoff #10 position at the exclusion of Brazil, India, or Russia, not to mention Mexico is a little questionable as well. Mexico...okay, but completely excluding all the BRICs and including South Korea sounds a little off to me.

    If South Korea were disregarded the next in line would have been the Netherlands which is another interesting country to analyze. I think that would have been more appropriate and consistent. If you're going to throw out the BRICs + Mexico then the authors should have thrown out South Korea and included the Netherlands.

    Their banking and insurance systems are incredibly leveraged as well. They are viewed like the Germans are, but once you consolidate their sovereigns contingent obligations they are in pretty bad shape, too, it just most market participants don't realize it yet.

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