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Debt Concerns Take Centre Stage In BSCC Economics, Investment Seminar

Tom Burroughes

9 May 2016

Angst over Chinese debt, US corporate borrowing and the potential risks from a Brexit vote and Japan’s vast experiment in quantitative easing were among some of the topics discussed when the British Swiss Chamber of Commerce held a breakfast briefing in London recently.

Paul Marson, chief investment officer of , were joined by WealthBriefing’s group editor Tom Burroughes on the panel discussion, held at the Grange, St Paul’s. WealthBriefing was the media partner for this event.

While currently overshadowed in the UK to some extent by the debate over whether the UK should stay in the European Union or leave, a good portion of the discussion focused on the economic and financial market positions of China, Japan and the US. Marson, for example, questioned the extent to which the US has significantly reduced borrowing levels since the financial crisis of 2008. 

“Banks and other financial entities in the US have cut leverage, and added equity, but the non-financial corporate sector as a whole hasn’t done so and has a record level of credit market debt outstanding. From a global perspective, total credit market debt outstanding amounts to over $240 trillion, a record level, and continues to grow at a pace in excess of nominal income,” Marson said.

“This is a large issue for the US,” he said. As far as the Chinese economy goes, Marson said the total size of the balance sheets of banks in the country were up to 3.5 times the size of the country’s gross domestic product (GDP is around $10 trillion). The country is seeking to adjust from a manufacturing-based, high-investment model to a more developed one, and the transition is likely to be painful, Marson said. “The adjustment process in China is going to be both prolonged and costly and has the potential, if managed incorrectly, to trigger the greatest financial catastrophe in history. Levels of bad loans already identifiable imply a bank recapitalisation bill that could exceed $4 trillion, or 40 per cent of GDP, and with debt growth at the present extraordinary rate the cost is surely increasing,” he warned.

Choyleva responded to Marson’s point about US corporate debt by noting that non-financial firms’ ability to service their debt is fine, but said household debt has fallen to more sustainable levels since the financial crash. The government is also in a position stabilise its debt-to-GDP levels. She also argued that a failing among central bankers in recent times has been to co-ordinate interest rate and other policy on a global basis.

Both speakers said they are concerned about Japan; Choyleva said Japan’s high debt and its heavy QE programme pose high risks, particularly as and when the Bank of Japan runs out of assets to purchase from the banks and will need to start purchasing assets from non-banks. 

“Japanese banks are particularly vulnerable to the effects of prolonged QE, a combination of rapidly deteriorating earnings prospects as bond yields fall and loan growth remains structurally anaemic, together with a high and rising level of cash in the economy (cash in circulation is 19 per cent of GDP already, almost 5 times that in the UK or double that in Europe), threaten their stability,” he said.

On other topics, Marson, when considering the UK’s referendum on the EU, said that the UK has the benefit of a “perpetual option” to leave the EU at any time but the present moment is not ideal, given the UK is borrowing heavily and has a large current account deficit. A Brexit vote, and uncertainties around the next steps, will make it harder for the UK to finance that deficit, he said. “The UK needs to attract net foreign capital annually amounting to 5 per cent of GDP or £90 billion, the faintest risk of a wobble in global investor confidence, for whatever reason, could prove extremely troublesome for the UK economy where the household deficit is already near 2 per cent of GDP, the highest level of net borrowing in decades,” he said.

Asked about certain asset classes, Marson said he regards UK equities as cheap in terms of valuation, while the US equity market is pricey at 25 times earnings. As for private equity funds, Marson said supposed diversification benefits are an illusion because net of fees and leverage they typically deliver just small cap listed equity index returns. Moreover, illiquidity is not rewarded. It is costly and illiquid diversification versus a small cap index”

Conversation turned to what is the best model of wealth management firm to put investment ideas to work. Marson and Choyleva both agreed that there are clear benefits to investment being undertaken by relatively small organisations to avoid consensual, crowd-like behaviour. “If you have a huge number of people in an organisation you end up with groupthink,” Choyleva said.

A problem, however, is that smaller wealth management firms are disproportionately affected by regulations. Marson agreed, adding: “There will be more consolidation and it is driven by regulations that are crippling.”