Spotlight

Unsustainable: Why debt will continue to rise

Our forecasts have pointed to dwindling future growth prospects across almost all major economies relative to recent decades. We expect worsening demographics, peaking globalization trends, the diminishing benefits derived from higher debt, the unintended consequences of easy monetary policy, and unfunded entitlement promises will all contribute to sluggish growth.

By: Dirk Hofschire Vadim Zlotnikov

Updated: 11/5/2021

Key Takeaways

Slower growth on a long-term basis
Increased fiscal pressures
Rising sovereign debt/GDP ratios

Slower growth on a long-term basis

As accumulated debt hits record-high levels, the marginal boost to GDP growth may actually be negative. Total economy-wide debt is substantially higher in many of the world’s largest economies compared to the decade before the global financial crisis, but average GDP growth rates have been slower in recent years.

Real GDP Growth: Next 20-Year Forecasts vs. Past 20-Year Rates

Past performance is no guarantee of future results. GDP: Gross Domestic Product. Source: OECD, Fidelity Investments (AART), as of 5/31/20.

Increased fiscal pressures

Worsening demographics are likely to increase political support for spending on social welfare programs, but most countries have not fully budgeted for the costs associated with larger and growing retiree-age populations. Unfunded liabilities for U.S. federal entitlement programs, for example, are roughly three times annual economic output and are likely to add to the country’s debt burden.

This situation is not improved by ever-more accommodative monetary policies that have negative side effects and may actually reinforce slower growth trends. For example, low interest rates aimed at spurring borrowing and consumption have instead driven up savings rates. For a fuller investigation, see our paper “Unintended Consequences of Extraordinary Monetary Policies” below.

Medicare and Social Security Obligations in Perspective

Congressional Budget Office, Bureau of Economic Analysis, 2019 Annual Report of the Board of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, Fidelity Investments (AART), as of 12/31/19. GDP: Gross Domestic Product. Source: OECD, Fidelity Investments (AART), as of 5/31/20

Rising sovereign debt/GDP ratios

We estimate sovereign debt/GDP ratios of most advanced economies will climb steadily, and these ratios could expand even more dramatically in the wake of the COVID-19 pandemic.

Many leading economies, including the U.S., are either at or approaching the traditionally high-debt threshold of 100% debt/GDP. Historically, no country has achieved a perpetual escalation in the debt/GDP ratio. The highest levels of debt ever achieved all topped out around 250% of GDP, including the UK and the Netherlands in the 19th century, and the UK, France, and Japan after World War II. Using our long-term GDP forecasts, we believe sovereign debt levels will rise markedly in the coming years. Under this scenario, several countries would surpass the highest levels of debt on record.

Sovereign Debt/GDP for the Most Indebted Countries on Record

Source: IMF working paper “A Modern History of Fiscal Prudence and Profligacy,” by Paolo Mauro, Rafael Romeu, Ariel Binder, and Asad Zaman (2013), Fidelity Investments (AART) as of 3/31/20.

There may not be a “magic number” that serves as a mathematical threshold above which debt levels immediately prove unsustainable, but there is likely a psychological threshold that eventually proves insurmountable. If it becomes obvious that inflation and currency depreciation are the only way out, creditors will be increasingly unwilling to finance higher debt levels at low interest rates.