Mother of All Bubbles: Global Debt May Be Understated By $13 Trillion

The US national debt was in the news last week as Pres. Trump signed a spending bill that raised the debt ceiling limit for the next three months and added approximately $318 billion to the national debt. Officially, the US debt surged to to $20.16 trillion. Of course, the actual figure for government unfunded liabilities runs even higher. And Trump wants to do away with the debt ceiling altogether.

The US debt makes up just one part of a rapidly growing worldwide debt problem. Earlier this summer, US Global Investors CEO Frank Holmes called global debt “the mother of all bubbles.” Now we have a report from the Bank of International Settlements saying worldwide debt may actually be understated by $13 trillion. Reuters reports the understatement is because “traditional accounting practices exclude foreign exchange derivatives used to hedge international trade and foreign currency bonds.”

Bank for International Settlements researchers said it was hard to assess the risk this ‘missing’ debt poses, but that the main worry was a liquidity crunch like the one that seized FX swap and forwards markets during the financial crisis. The $13 trillion unaccounted-for exposure exceeds the on-balance-sheet debt of $10.7 trillion that data shows was owed by firms and governments outside the United States at end-March.”

In an FX swap agreement, one party simultaneously borrows a currency from, and lends another currency to, a second party. Each party uses the repayment obligation to its counterparty as collateral, and the amount of repayment is fixed at the FX forward rate as of the start of the contract. As the BIS explains:

FX swaps have been employed to raise foreign currencies, both for financial institutions and their customers, including exporters and importers, as well as institutional investors who wish to hedge their positions. They are also frequently used for speculative trading, typically by combining two offsetting positions with different original maturities. FX swaps are most liquid at terms shorter than one year, but transactions with longer maturities have been increasing in recent years. For comprehensive data on recent developments in turnover and outstanding in FX swaps and crosscurrency swaps.”

The problem is FX derivatives don’t show up on balance sheets under current accounting rules. That means nobody really knows where the debt is. According to the BIS report:

“The debt remains obscured from view. Accounting conventions leave it mostly off-balance sheet, as a derivative, even though it is in effect a secured loan with principal to be repaid in full at maturity … In particular, the short maturity of most FX swaps and forwards can create big maturity mismatches and hence generate large liquidity demands, especially during times of stress.”

FX swaps are a pretty obtuse and complex subject. The bottom line is there may actually be significantly more global debt out there than people realize. And we already knew there was plenty. According to the Institute of International Finance (IIF), global debt levels reached a staggering $217 trillion in the first quarter of 2017. That represents 327%  of global GDP. To put that into perspective, before the 2008 meltdown, global debt was a mere $150 trillion.

We hear a lot of talk about debt, but nobody ever seems to think about the ramifications. How in the world to you pay down so much debt? Realistically, you don’t. At some point, the bubble will burst.

In the midst of bubble world, Holmes says investors should buy gold, and called the yellow metal’s long-term investment case “bright.” He said if and when the mother of all bubbles pops, it could potentially spell trouble for the investor who hasn’t adequately prepared with some allocation in a safe haven.

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