Next year and especially 2026 will prove to be challenging years for investors. Consider how, in the coming months, stock prices must not only defy investors’ doubts about growth and inflation, but by the end of 2025 they must overcome a large wall of maturing debt.
The above is a result of the accumulation of debts that were mostly taken out a few years ago when interest rates were low. Similar situations in the past caused financial meltdowns such as the Asian crisis of 1997-98 and the financial crisis of 2008-09. Notably, debt is constantly increasing while liquidity is cyclical – this is what causes the crises.
- History shows that financial stability requires a near-constant ratio between the debt stock and the liquidity pool.
- Excess debt relative to liquidity gives rise to refinancing crises, since maturing debts cannot be serviced.
- Conversely, any excess liquidity leads to monetary inflation and asset price bubbles.
It is therefore important that policymakers chart a middle course. Under the current burden of global debt estimated by the Institute of International Finance at $315 trillion in the first quarter, capital markets have turned into massive debt refinancing systems.
The balance sheets
In a world dominated by debt refinancing, financial sector balance sheets matter more than the level of interest rates.
About three out of four transactions now done through financial markets simply refinance existing loans. For example, taking an average seven-year maturity, this means that a whopping nearly $50 trillion of existing global debt must be rolled over on average each year.
Unfortunately, this requires ever greater 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 increased sharply of late.
Evidence is strong gains in asset markets, as well as record highs in many stock markets and the price of gold.
Global liquidity is being fueled by rising bank lending, supported by the improving value of the collateral backing the loans, and by a long list of central banks willing to ease monetary policy.
Global liquidity
In terms of global liquidity, recent estimates show an increase of $16.1 trillion over the past 12 months and an impressive jump of $5.9 trillion since the end of June to nearly $175 trillion – a pool roughly 1½ times the global GDP.
That equates to a seemingly healthy 15% year-on-year growth. However, going forward, markets will require even more liquidity to feed the insatiable glut of debt.
Since 1980, the ratio between global debt and global liquidity has averaged 2.5 times, and in the crisis year of 2008 it reached 2.9 times. It continued to rise during the Eurozone banking crisis of 2010-12.
By 2027, it is likely to exceed 2.7 times again. More worryingly, by 2026 the maturity wall, which measures the size of annual debt rollover for advanced economies alone, is likely to jump by almost a fifth, to over $33 trillion in absolute terms.
What can policymakers do to protect investors?
1. In the short term, the answer is explicit management of liquidity conditions rather than simple adjustment of interest rates. This may be unfashionable because it takes us back to the days of QE (quantitative easing) and QT (quantitative tightening) programs by central banks to prop up economies. And it runs the risk of overzealous central bankers creating ever-larger asset bubbles.
However, given large and embedded fiscal deficits and the recent shift, notably by US Treasury Secretary Janet Yellen, to financing them with short-term bills and bonds, we believe the global liquidity pool may need to expand by 8-10 %. In other words, “at this growth rate its total size will double every eight years.
2. In the long run, the only solution is debt reduction. With an aging population requiring ever greater and often mandatory welfare spending, this is a big ask for governments.
But if nothing more is done, the cost of the next bank bailout could make the 2008-09 bailouts look paltry.
