The International Monetary Fund, or IMF, conducted its 2018 spring meeting last month in Washington, D.C. The meeting was accompanied by some high profile interviews with IMF Managing Director Christine Lagarde.
The purpose of the IMF is to promote international financial stability and growth and to foster economic cooperation among its 189 member nations. I’ve always perceived the institution as a type of a consultant “watchdog” to the world’s central banks, governments and global financial institutions. The IMF also provides emergency financial assistance, mostly in the form of loan packages, to nations experiencing financial crises.
When the paranoid left talks about the “1%” or “global bankers” and when the conspiratorial right talks about the “elites” or the “globalists,” both have the IMF on their list of shadowy bad guys. I’ve always viewed it as more academic than evil. The IMF makes too many mistakes to be all powerful, in my opinion, and it often provides good insight and words of wisdom for investors to digest.
Last week, its words of wisdom were widely reported in the financial press. While it is a little ironic that an institution whose primary tool is emergency loan packages would be warning us about global debt, its warnings were clear, and all investors would be wise to keep the insight coming out of the IMF somewhere on the list of things that could keep them up at night.
Lagarde did time on about every financial channel I follow, revealing IMF research indicating global debt levels of public and private debt have now reached 225 percent of global GDP. This is the highest global debt level in history. While the growth in debt levels is particularly concentrated in emerging economies like China and Brazil, the U.S. also made the list of potential problem centers as our Federal government seems completely ambivalent to running up the national debt regardless of which party is in power.
After 10 years of interest rates far below historical norms, interest rates are continuing to rise, which will cause debt across the spectrum to become more expensive and less sustainable. I’ve spent some time thinking about the issue, and while academic discussions of global economics are fascinating, I thought I’d be a little more specific about what types of red flags will emerge if this issue begins to boil over.
As interest rates rise, a potential early red flag could come out of highly indebted medium to large emerging economies such as Mexico, Brazil, Turkey, South Korea or, in a worst case scenario, China. The red flag will entail a potential bond default.
This red flag could be particularly problematic if the nation in trouble has borrowed using bonds repayable in U.S. dollars. If the majority of a government’s bonds are repayable in its own currency, any instability may be easier to contain.
When a government is at risk of defaulting on its debt (usually bonds), it's important to know whom the government actually owes money to, or who owns their bonds and stands to lose money. In the modern financial system, bonds are likely to be owned by global financial institutions, aka big banks, or in some cases mutual funds and pension funds.
With debt being at such high profile high levels, I would expect any inkling of stress in one of these larger emerging economies to cause immediate violent reverberations in global financial markets. Higher debt levels means less stability when things go wrong, and as interest rates rise, investors will need to be paying attention to this issue.
As far as our own government goes, things are a bit more complicated. With a $4.4 trillion “budget” and $21 trillion in debt, it's likely the size of the federal government will soon peak. As rates rise, I would first expect austerity before instability. As long as the Federal Reserve is able do quantitative easing to stabilize the U.S. financial system, the federal government is able to buy some time.
Eventually, however, it will need to get its house in order, and that won’t be fun.
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial in Crown Point, Indiana. Contact him at firstname.lastname@example.org.