[MUSIC] Thomas Edison penned the following in a 1921 New York Times article, quote, any time we wish to add to the national wealth we are compelled to add to the national debt, unquote and he was right. As we explored in the previous video, a measure of debt may be required in order for a country to grow its wealth. However, we ended with the question, how much debt is too much? Whether it is personal, corporate or sovereign debt, there is a tipping point that triggers financial distress, bankruptcy and national and international economic crisis. Of course, sovereign debt is unique in a lot of ways not least of which, because it is owned by a powerful collective entity that by the very virtue of being sovereign is not beholden to the same legal rules as an individual or a firm. But countries are still subject to the same sorts of financial or economic laws or forces as all other financial actors, namely that you cannot escape your debt obligations by simply borrowing more or by rescheduling your debt to pay it back later or just printing more and more money. This power vested in governments to print more money has become, especially insidious, which we explored earlier in the markets cost by looking at the ineffective interest rate policies of the central banks and that's worth revisiting again. In every level, this kind of compounded borrowing and the desperation that comes from not having enough is how people in gangster movies end up with broken legs. And despite the telltale signs, it continues to happen quarter after quarter and year after year with both rich and poor countries continuously adding to their national debts. To the point where today, total global sovereign debt is by some estimates, approximately $60 trillion. While this number is staggering, the exact amount isn't as important as the fact that since the mid-70s, the number and payment default statistics have been higher and higher and those leading the way are the worlds wealthiest countries like Japan and the United States. You don't have to be an expert to understand that this trend Is unsustainable. Not least, because it poses a threat to the stability of the global financial system. So, it's worth asking how is this possible? And why an excess of sovereign debt is so destabilizing? The first of these questions has a number of interrelated answers, but one of the most important factors enabling the continued escalation of sovereign debt Is the emergence of negative yielding bonds in recent years. As we learned in the markets course, negative interest rates are really counterintuitive. Indeed, it's usually assumed that by taking on additional debt that makes the next round of borrowing even riskier. So, shouldn't the country's cost of borrowing increase as it takes on more debt reflected by a higher interest rate? But with negative interest rates, the situation is inverted. With trillions in global debt in the form of bonds, that promise to pay investors less than what they paid in. Investors are attracted to these investments, because the country is issuing these bonds are considered politically and economically stable and associated with low risk. So in an increasingly uncertain and turbulent world, it might be safer to park your savings at a negative yielding bond at a small cost than to invest elsewhere in search of potentially high returns that unlikely to be realized. This situation makes it much easier, especially for wealthy and traditionally stable countries to accumulate greater debt. A point that segways into the second question about why this can be destabilizing to world markets. With negative interest rates, the main issue here is that these trends have put the global financial system in uncharted waters. Indeed, almost nobody had even heard of negative yielding bonds just a couple of years ago. Then in early 2015, globally, they jump to 3.6 trillion. Just a year later, they doubled. And six months after that, the amount skyrocketed to over $10 trillion by the middle of 2016. 1 trillion, let alone 10 or 60 trillion is a staggering amount of money. This amount is larger than the entire value of goods and services produced in India or Russia and certainly more than Italy, or Brazil, or my home country Canada. Economists, financial analysts as well as plain common sense tells us that this kind of trend is unsustainable. Because as we mentioned earlier, the consequences of continuously adding debt cannot be sustained. This is particularly apparent today as many governments around the world face major fiscal deficits. Meaning, what they owe both in terms of debt to investors and in outlays to fund social programs, infrastructure, national defense and other core, government obligations is higher than the revenue that they're able to bring in. Let's take the US as an example by looking briefly at the American federal government's balance sheet. Remember, a balance sheet is a snapshot of a country's assets, liabilities and equity at a given point in time. Let's first consider assets, which are what you own or anything of value that can be converted into cash. There are many issues we might consider here, but I want to talk about one particularly disturbing item, which I raised before within these government assets that has effectively trapped the younger generation, student loans. I'm glad that this topic received a lot of press in the debates leading up to the US election, but besides owning deteriorating infrastructure like, bridges and roads or national parks and all of the weapons systems in the US military. Student loans now represent $1 out of every $4 that the US government owns. According to adviser perspective since the great recession of 2007 and 08, federal loans to students have increased an astonishing 853% and now represent over 45% of the government's financial asset. These numbers are wrong. This still suggests that the richest nation on earth finds its young people in serious debt and it's counting on their repayments to balance their books, which is not exactly a sure thing since most of today's students are unlikely to ever find the kind of stable lifelong employment enjoyed by their parent's generation. If you're not impressed with these kinds of numbers, all with the assets side, then the numbers pale in comparison with the liability side. Liabilities represent what the government owes. But despite what some US presidential candidates have said, most of these liabilities is owed to American citizens and not to the Chinese. Therefore, the money owed must be settled amongst Americans themselves. Imagine how that might play out by considering the numbers. Total liabilities are now exceeding $19 trillion, which is approximately 107% of GDP. Meaning, it's more than the value of everything the country produces combine. To put it in another way, the state of the US balance sheet today has every single American owing about $60,000 and this number does not even include the state and local debt or the cost of what we call entitlement programs. Meaning, things like Social Security and Medicare for senior citizens, which currently take up almost half of the US federal budget. So if you add both of these to what the US government owes, the total liabilities jump to over $90 trillion, an amount greater than what all countries in the world produced. You don't have to know a lot about numbers to see this squeeze here, but they key point is that the US balance sheet has not zero, but negative equity, which is the difference between assets and liabilities. Now, this would almost certainly bankrupt any firm. But as we mentioned earlier, the unique character of sovereign debt makes the situation much more possible for a country than it would be for a household or a company. It's not only about how big a nation's debt is. It's also about reaching the limit at which debt management becomes an illusion. At that point, money will need to be created out of thin air, which we know is impossible, but I think we have to ask some big questions in this regard. So, I'll conclude that our story of global government debt is one that is showing the most stress. The economic pillars that have given government historic ability to withstand shocks in the system are under duress and it is critical that we recognize that sovereign debt is not just a side effect of policy decisions, it directly impacts each one of us. So, it's prudent for each one of us to consider these developments in our own personal assessment of whether global debt markets are at a turning point that will change our own lives. We need to formulate a plan A, perhaps we need to formulate a plan B. That speaks to what we individually and collectively are going to do about this in order to protect ourselves, protect our families and the communities that we serve.
