Leverage matters

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9. Mai 2019

Salman Ahmed, PhD

Chief Investment Strategist

A stark rise in leveraging by non-financial corporations and households globally since the 2008 financial crisis has raised concerns. While we do not believe that high leverage¹ will be the source of the next crisis, we caution that very high leverage does increase the global economy’s vulnerability to shocks.

Risks from an interest rate shock are well-recognised, but we highlight that an income shock could damage the global economy more. The collapse of the US housing market in 2006-2008 provides a good example of how harmful a combination of income and interest rate shocks can be.

High levels of leverage are already changing the way central banks conduct monetary policy, both during the current cycle and more structurally.

In the longer-term, the global economy (in particular, in countries such as China) will need to de-lever. Different forms of de-leveraging are possible with varying implications for investors.

Macroprudential policies are better at preventing the excessive accumulation of leverage before it becomes a destabilising force, rather than reducing it.

Allowing inflation to settle higher is one solution to force a faster reduction in indebtedness and central banks can play a very powerful a role.

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¹ Leverage measures borrowing relative to income, company earnings or a country’s GDP. Private leverage measures debt relative to individual income. Company leverage typically measures the ratio of a corporate’s debt relative to earnings (such as EBITDA). Government leverage is usually measured by the ratio of government borrowing relative to GDP.

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