From PIMCO
The Reinhart/Rogoff book speaks primarily to public debt that balloons in response to financial crises. It is a voluminous, somewhat academic production but it has numerous critical conclusions gleaned from an analysis of centuries of creditor/sovereign debt cycles. It states:
The true legacy of banking crises is greater public indebtedness, far beyond the direct headline costs of bailout packages. On average a country’s outstanding debt nearly doubles within three years following the crisis.
The aftermath of banking crises is associated with an average increase of seven percentage points in the unemployment rate, which remains elevated for five years.
Once a country’s public debt exceeds 90% of GDP, its economic growth rate slows by 1%.
A different study by the McKinsey Group analyzes current leverage in the total economy (household, corporate and government debt) and looks to history, finding 32 examples of sustained deleveraging in the aftermath of a financial crisis. It concludes:
Typically deleveraging begins two years after the beginning of the crisis (2008 in this case) and lasts for six to seven years.
In about 50% of the cases the deleveraging results in a prolonged period of belt-tightening exerting a significant drag on GDP growth. In the remainder, deleveraging results in a base case of outright corporate and sovereign defaults or accelerating inflation, all of which are anathema to an investor.
Initial conditions are important. Currently the gross level of public and private debt is shown in Chart 2
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