[MUSIC] So far in this course we've explored debt levels of households and farms. And noted that both sectors are at a record high and on unsustainable trajectory with household debt. Mortgages are the largest portion or about two-thirds of the total, followed by car loans, then student loans and each of these is larger than credit card loans which are considered bad loans because this source is the most expensive and it's the hardest to manage. A recent financial times headline quote, $18 billion credit card debt spree sparks fears, unquote. Points to the banks aggressively lending at the fastest pace since 2007. Significantly increasing risks of over extended credit. When you add up all households who have borrowed, the average family owes about $130,000 with over $15,000 from credit cards alone. With roughly 10% of their income that must pay interest on these loans. The higher level of household debt may not come as a surprise in a record low interest rate environment where cheap money entices consumers to borrow and spend. The problem however, is that the majority of consumers have low paying jobs that do not regenerate sufficient incomes to support their spending. In other words, personal debt has become a crutch that exacerbates shortages rather than as a lever to improve wealth. In simple terms it is clear that the over indebted household sector is under financial stress with dim prospects for recovery. And since the largest global economy depends heavily on consumer spending from this sector, current monetary and fiscal policies can do little to squeeze more out of them. So as the last video suggested, given a fragile consumer credit markets piling on more debt is a recipe for extreme turbulence that households must be prepared for. I wish the picture was better in the corporate debt markets where trillion of dollars that are worth monitoring given their size and reach which is significantly larger than global stock markets. The Wall Street Journal described the newborn markets as quote, bigger, riskier, and more fragile than ever, unquote. Blumberg wrote that it could trigger a recession. Concerns echoed in the Standard and Poor's Global Ratings Report, which despite sharp rises in debt default rates since 2009 shows corporate debt projected to continue increasing at astonishing rates. We have seen that corporate debt has significant advantages over equity on the certain conditions. More debt, favors, and benefits from who use it as financial leverage because it is cheaper, and it can dramatically magnify returns as well as increase the value of those firms. But this only happens if such increases are accompanied with growth. This point was underlined in a previous video with the cautionary tale that firms experienced the exact opposite, or loss in returns and in value during economic stagnation and downturns. With higher debt ratios and widespread economic indicators of a global economy stuck in a deflationary environment with anemic growth forecast that are mostly in the one point something percent range. Today's data suggests that many firms are quickly using up their financial flexibility. And again, this means they will be more vulnerable to not only cyclical and recessionary downturns with negative returns but are also likely to experience a sharp reduction in their values when there is insufficient cash flow to pay for binding obligations that will be due once this debt party is over. Of course, these debt happy conditions are exacerbated by cheap money that has encouraged large-scale borrowing. The policy makers in the central banks and government leadership understand this, having engineered these condition in the first place. However, one must assume that government and policy makers are either blinded by their own temptation. In what continues to be a spectacular global debt run or find themselves stuck in a situation where they can no longer manage the debt because it is now managing them. To fully understand the centrality of debt beyond households and corporations as well as other financial institutions operating in the sophisticated financial markets we have described. In this specialization, let's take a closer look at the global money flow in the 21st century which is largely influenced by the debt or bonds held by the world's countries. Most people realize that nations are the largest holders of debt by far, but aren't sure why the magnitude of debt is important or how does debt impacts their own lives. So let's start by recognizing the nature of debt held by a counties government, which is generally called sovereign debt. With sovereign being the technical word for the independence of a nations state. Sovereign debt raises massive rounds of money through bond issues denominated in a reserve or foreign currency. Typically from external investors who must be paid back in the currency these bonds are issued in. This means that the government buys that currency in global markets. And that resolve currency is still overwhelmingly US dollars which makes it relatively cheaper for the US, who does not have to worry exchange rate, fluctuations when they issued debt. However, because the US is also the biggest debtor nation on Earth and because of political forces that have increased financial uncertainty and think of Brexit, think of the Italian crisis that is looming and the US elections. These are pretty good examples of recent destabilizing events. The market has seen significant shifts. Now these shifts include the dramatic re-evaluation of the price of gold. And the gradual adoption of the Chinese. There's lots of talk about a financial reset for an alternative reserve currency and the role of gold. Here, Dutch born Willem Middelkoop, financial historian and fund manager gives us a really good in depth perspective of these issues in a YouTube interview by describing past research such as the Breton Woods Agreement in 1944 and the removal of the Gold Standard by President Nixon in 1971. All of these pointing to the increasing likelihood of another big reset that he believes is imminent. The majority of the poor and developing countries, however, don't have the credit capacity to borrow directly and issue sovereign debt in global markets which forces them to go through international institutions such as the World Bank who then imposes its own conditions. To insure that the country in question is able to pay back their debts. Of course, government also borrow internally from their own citizens. We explored the origins of this idea in course two in markets going back to the magnificent times of the Medici's, Michelangelo and Machiavelli when it became clear to governments that taxation itself was insufficient to meet their needs. Greater sums of monies were required to recover from the acts of God and disease, to finance wars waged and battles won and lost. For large scale infrastructure projects, and after World War II, to meet promises of social security and health care. All of which have kept governments relying on external and internal debt. In this regard, it's quite interesting how widespread the litany of sovereign debt defaults is in all corners of the globe. When a government default is believed to be imminent, as was the recent case of the so-called European PIGS, Portugal, Ireland, Greece, and Spain. Those sovereign debt crises where investors, which were mostly big banks from around the world, bought bonds from these troubled economies. And then tried to sell them very quickly as they lost value. This pushed the price of the bonds lower and the bond interest rates or yields higher. In the case of the desperate Greek government, they were forced to issue expensive higher yielding bonds to attract newer investors to compensate for higher risk. Global financial institutions like the IMF, the International Monetary Fund, or the ECB, the European Central Bank provided loans to stave off the Greek default and facilitated an orderly debt restructuring. But also they imposed strict conditions involving political reforms and economic sanctions that led to what is known as austerity. These actions meant belt tightening for everyone and obviously hurt the poor and the financially literate more so than others. What is bewildering, however, is that countries like Spain, which was on the brink of default not long ago, with dangerous levels of public debt. Are now able to issue very low or 0% sovereign debt thanks to the banking of the European Central Bank. This is a clear example of how markets are now mispricing risk. But the picture is getting bleaker in Italy, Europe's fourth biggest economy. Italy recently made the cover the Economist magazine as it teeters on becoming Europe's next sovereign debt crisis. The Economist reports some startling statistics including severe unemployment in Italy, deflation, government debt at 135% of GDP, and bad loans of some $400 billion, which amount to 20% of the income the country produces. While there has been a massive sell off of Italian banking shares that own most of the toxic debt, for the complication here, includes the majority of bond holders who are retail investor which means that the wealth of most Italians will be reduced very quickly as this bond market unravels. All of this is just to say that an Italian default would undoubtedly be catastrophic not only to the E.U. but it would also destabilize the global financial system. Now unlike poor countries who must reform and tighting their belts, develop countries who are borrowing an unprecedented levels use a counter argument to borrow more and spend their way out of whatever ails them. If consumers and businesses are not spending enough, the government borrows and spends. If the banks are faltering, the government borrows and spends. We have already seen the same pattern with Japan, the second biggest economic giant that has, for decades, been largely unsuccessful in it's reform to get out of it's own made in Japan death trap. This debt saga is a case study of how a major economy can remain stuck for decades. With the more recent unorthodox central bank actions to print unprecedented amounts of money, and issue negative yielding sovereign debt increasingly illustrating desperate measures of the last resort. In some the global debt market is bloated and uncertain, and is raising more red flags than anyone cares to see. But we are still left with the root question of how much debt is too much debt?
