As inflation soars, new data shows...
...many Americans are charging
Little concerned about
The mobile that you're watching
You watch those things
Debt
What do you think of when you hear this word?
We have an affordability crisis...
...in the United States
Everywhere you look, the colour is red
We're all taught to think of it as a crippling obligation
But debt is one of those things...
...that makes the world go round
Credit card debt has jumped 13% in one year
We want to be able to buy a house...
...and we don't have a house yet
Buying a house...
...starting a business, investing, funding tuition...
...debt can be used to finance...
...all of these
Credit card debt
Definitely you want to be paying down...
..the credit card debt
Food costs are going up...
...energy costs are going up...
...rents are skyrocketing
Debt is going up...
...so that we can pay the interest on the debt that we have
I don't think it's going away anytime soon
So what misconceptions do you have about it?
How does debt really work?
Private debt can be divided...
...into two kinds...
...for consumption and for investment
It can also be divided...
...into personal and corporate debt...
...who borrows the money?
Debt for consumption...
...is often for credit card use...
...or for big ticket items like houses, cars and tuition fees
Imagine if you had to save up...
...to buy a house
You wouldn't move in...
...until it was time to retire
Debt lets you have it today...
...and pay for it tomorrow...
...usually with interest, of course
What causes lenders and borrowers...
...to come together then?
When we value...
...how much money is worth to us...
...we also take into account...
...when we have it
The same amount of money is worth...
...more today than tomorrow
If I can buy something with it now...
...it's better than later
A borrower may see money in the future...
...as being less valuable than money now...
...and the lender may see future money...
...as being more valuable than the money they have now...
...because there is nothing better...
...they can do with it at that moment
It's an exchange that works...
...for both parties
Here's Justin MacQueen, our market specialist...
...with the lowdown on how borrowing works
Borrowers borrow money...
...they can invest it in R&D...
...or other investments...
...or even receive interest on that
Because lenders recognise this...
...to lend out money...
...they would therefore ask for a premium...
...in the form of interest
So they get paid by lending out the money
The time value of debt...
...for investment works the same way
This kind of debt is known as leverage
Leverage is used by corporations...
...and traders to invest for a return
Companies can borrow to fund new ventures...
...that make all the things you like to buy
And investors who make a good call...
...can magnify their returns...
...using someone else's money
Take US corporate debt
It's been on a continuous...
...upwards trajectory going back to 1980
This spiked at the start of the pandemic...
...reaching over seven and a half trillion dollars today
So with interest rates rising...
...are US corporate debt's sustainable?
Debt isn't as simple as being a burden...
...you should avoid, or a limitless source of cash
Now that we've been over...
...how debt is structured...
...we can look at the bigger picture
What's this all for?
Sure. I'd like to live in a house now
And of course...
...I'd like to be able to pay for that nice car
So why does the bigger picture...
...matter to me?
Debt makes the economy go around
It fuels consumption, funds investment...
...and central banks use it to control inflation
Credit means you can have the money...
...to fund your purchases...
...now, rather than later
This stimulates demand, and more consumption...
...means more economic output
Interest rates are the cost of credit...
...and by extension, the cost of money
The lower it is...
...the cheaper it is for you to borrow
The cheaper the money...
...the more you can afford to borrow
Central banks control...
...base interest rates...
...by raising rates...
...during times of high inflation...
...they can make borrowing more expensive...
...cooling down the economy...
...and lowering inflation
We've also made a film about this subject...
...which you can watch by clicking on the link
After 2008...
...central banks lowered interest rates to all time lows
They did this...
...by controlling the base rate...
...and raising bond prices...
...with quantitative easing
This was to get the economy...
...moving out of recession...
...and create inflation...
...by stimulating demand
Here's Justin again
Essentially, a central bank would buy...
...government bonds...
...which would therefore mean that...
...the price of the bond increases...
...the interest rate on the bond...
...will therefore decrease...
...and subsequently...
...that would allow for more...
...borrowing to take place...
...within the economy...
...and therefore generates...
...inflation going forward
This demand goes both ways
Stimulating investments...
...by making it cheaper...
...and fuelling consumption of those big ticket items...
...we mentioned earlier
US credit card debt from 2013 to 2020...
...had been climbing
A consistent trend upwards for years...
...until the pandemic upended old consumption patterns
The recovery has seen a return to old habits...
...but at a lower level
It currently sits on $890 billion
College debt, or uni for you Brits...
...can be a big burden to young graduates
In the US Student debt is even larger...
...than credit card debt was at its peak in 2020
And on average, American graduates...
...owe around $37,000 for tuition fees
Given that the US rate of inflation...
...is at decades long highs...
...and rate rises have been coming thick and fast...
...we need to get into what America's...
...household debt situation is really like
While debt makes the economy go around...
...too much of it can hold it back...
...rather than help it
when private debt in the economy...
...gets too high...
...It just can't be repaid
This is called debt deflation
Credit is money
When it's lent out, new money is created...
...and added to the money supply
When debt is repaid...
...that money is destroyed
But when private debt levels grow too large...
...it cannot be paid back...
...without increasing the real value...
...of the remaining debt
Leaving the real value of debt...
...exactly where it was
Is the US in this situation?
We can only speculate...
...but it could be in a debt deflation cycle
Let's look at total US private debt
When looking at the total scale of debt...
...it's useful to look at debt to GDP ratios...
...rather than just the raw figure
This is because the ratio to GDP...
...will show how affordable it is
US private debt to GDP levels...
...stand at over 220%
This is lower than it was in 2020 when it peaked...
...and it's even lower than it was in 2007
So while the US may have high debt levels...
...which can't be ignored...
...over the past two decades...
...its private debt burden has remained steady
The same cannot be said for mortgages
Mortgage debt levels are even higher now...
...than they were in 2007...
...just before the 2008 housing crash
If you want to know more on...
...whether there could be another real estate crash...
...click here...
...to watch our recent debate on the subject...
...it's really interesting
Let's not forget about US Auto
They, too, are on a similar trajectory to mortgages...
...heading onwards and upwards
Auto loan debt in the US...
...currently sits at $1.5 trillion dollars...
...even higher than credit card debt
Private debt in the US...
...doesn't all work the same...
...but almost all of it is going in one direction...
Up
And that's kind of worrying
Is this just what happens...
...when economies grow?
The thing is,...
...US private debt to GDP...
...hasn't increased much over the past 15 years
Or is it rising...
...just because of low interest rates?
And what will happen to all this debt...
...as rates rise?
While rising interest rates from...
Various central banks, most notably...
...the Federal Reserve...
...will make it a lot harder for companies...
...who have overleveraged on near zero interest rates...
...it will be much harder for them...
...to service that debt next year
Now, of course, that can probably lead to companies...
...facing the risk of bankruptcy...
...but the US as a total...
...I think the rate of change that we've seen...
...since the COVID crisis...
...is not sustainable...
...but the total level itself...
...I would argue, that is still pretty sustainable
Interest rates are rising
This is a fact of life...
...that economies will have to deal with...
...until inflation is tamed
But how high could they go?
Yep, you know the drill
We've also made a video on that topic
You know where to click...
...but we're almost finished with this narrative...
...so just bear with me a little bit more
On a related note...
...how high could inflation go?
I mean, how long's a piece of string?
What we do know...
...is that inflation in many Western countries...
...has been persistently high
Reaching highs of 10% in the UK...
and 8.5% in the US
Fed inflation targets are 2%
And the only tool central banks have...
...to fight inflation is rate rises
Rate rises mean the cost of future borrowing...
...gets more expensive...
...and the cost of servicing existing debt...
...goes up
How well-positioned...
...are families and businesses...
...to handle this?
It seems not very well
Borrowing costs are going up...
...and the days of cheap money...
...could be over
Refinancing costs are rising...
...and have hit a global record
Globally, bonds are in decline...
...as seen with the recent crisis...
...in UK government bonds
The corporate bond market...
...is not coping well either
Interest rate rises are rattling investors...
...and threatening corporate profits
As we mentioned...
...corporate debt is at all time highs
And rising rates will make this harder to sustain
As the global economy...
...is suffering through the after effects...
...of the pandemic...
...through the war in Ukraine...
...and other supply problems...
...corporate profits and personal incomes...
...may suffer from rising rates
For companies that can face pressure...
...going into the New Year...
...will be particularly...
...those unprofitable companies...
...that borrowed excessively...
...during the period of low...
...interest rates back in 2020 at a time...
...that we are starting to see a pick up in...
...auto loan delinquencies
So as the cost of debt rises...
...a bear market sets in more and more
It may well be that...
...with the era of raising rates...
...the global debt bubble may be coming...
...to an end
in the era of rate rises...
...it begs the question...
...what do I do with my finances?
Should I save?
Should I invest, or pay down my debt?
You could have so much in savings...
...that it's a no brainer...
...to pay down your debt now that rates are rising
Rising interest rates will continue...
...to place pressure on the broader market...
...and as we've seen over the past year...
...the tech companies have been...
...one of the hardest hit areas...
...and with regards to rising interest rates...
...also...
...as well the rate sensitive areas, particularly...
...the housing market, will also come under...
...significant pressure over the following 12 months...
...on the back of these...
...aggressive rate hikes...
...that we've seen from the Federal Reserve
Over the next few years...
...we're likely to see the consequences...
...of rate rises...
...and the Build-Up of debt...
...during the pandemic
What we might be witnessing...
...is the latest in an ongoing cycle...
...of debt accumulation...
...that simply will continue...
...while we have a market economy
thanks so much for watching
You can read more of our original market analysis...
...by visiting our website Capital.com
There's a link in the top right corner...
...and also in the description
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I'll see you next time