The Great Wall of Debt

Could World Markets Crash Into The Fast-Approaching Debt Maturity Wall?

We are not turning bearish yet! Rather we highlighting potential upcoming investment risks. There is a looming debt problem on the horizon that adds to our concerns that 2025 will prove tougher for investors when the Global Liquidity cycle peaks and starts to decline, as the chart below shows.

If bull markets always climb of 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 the World’s teetering tower of maturing debts. 2025 and particularly 2026 will prove challenging years for investors. Over coming months, stock prices may not only have to beat-off growing investor doubts about future growth and inflation, but by late-2025 they will have to scale a sizeable maturity wall of debt. This term describes the bunching in the refinancing of those corporate debts mostly taken out, a few years back, when interest rates were rock bottom. Similar refinancing tensions have triggered several past financial meltdowns, evidence the 1997/98 Asian Crisis and the 2008/09 GFC.

Weighed down by US$350 trillion of World debt, financial markets are forced to act more-and-more as giant debt refinancing mechanisms, but their gears can mesh when there is insufficient liquidity available to lubricate the transmission. Tensions arise because debt grows exponentially whereas liquidity is cyclical. History shows that financial stability requires a near-constant ratio between the total 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, whereas, at the other extreme, too much liquidity leads to monetary inflation and asset price bubbles. It is important that policy-makers steer a middle course.

This is not the standard textbook argument, which still views capital markets primarily as new financing mechanisms for capital spending. There was rough equivalence between the size of the annual debt roll for the Advanced Economies and their spending on new capex in 1980, but by year 2000 debt refinancing was twice as big, and by 2026 it will be almost a whopping four times the size of prospective new capex spending.

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. Taking an average 7-year maturity, this means than a whopping US$50 trillion of existing debts 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 World financial markets has lately been rising strongly. Evidence the recent solid gains across risk asset markets, and tick-off the all-time records set both for many stock market indexes and by the gold bullion price. Global Liquidity has been fueled by rising bank lending and underpinned by improving collateral and by a long list of Central Banks eager to ease. Our latest estimates show a US$16.1 trillion increase in Global Liquidity over the past 12 months and a more impressive U$5.9 trillion jump since end-June to reach US$175 trillion: a pool roughly 1½ times World GDP. This equates to a seemingly healthy 15% annualized expansion.

But there is no hiding from this looming maturity wall. Markets will demand even more liquidity to feed the rapacious appetite of debt. Debt rolls require balance sheet capacity across the financial sector, which is essentially ‘liquidity’.

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 (2010-12). These calculations also adjust the size of debt for its maturity profile. Refinancing tensions arise when the ratio moves significantly above the 250% long-term average. It gets close in 2025, but jumps above this danger threshold in 2026.

By 2027 this debt/ liquidity ratio is likely to again exceed 2.7 times. More worryingly, by 2026 the maturity wall, which measures the size of the annual debt roll not only breaks above average, but it jumps by nearly a fifth to over US$33 trillion in absolute terms, or three-times the annual spend by the Advanced Economies on new capex.

What can policy makers 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 QE (quantitative easing) and it runs the risk that over-eager Central Bankers subsequently inflate ever larger asset bubbles. Nonetheless, given big and embedded government budget deficits, and noting the recent shift 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% clip. Put another way, at this growth rate its aggregate size will double every eight years. This, of course, could be music to the ears of gold bulls and holders of other monetary inflation hedges like Bitcoin.

In the long term, the only safe 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 bail-out could make the 2008/09 rescue packages look like the lunch bill.