Credit and related interest income have historically been viewed as service and related payment for lending productively. However, in a highly collateralized and risk-averse financial system credit may be granted mainly on the basis of collateral value and aim at wealth extraction rather than wealth creation. On the macroeconomic level, this creates unproductive debt, i.e. debt that is not backed by productive investment. This type of debt carries greater systemic default risk. The rapid increase of debt and leverage after the great financial crisis may be an indication of an unproductive debt problem. For the purpose of macro trading, relevant systemic risk indicators should feature intelligent debt-to-GDP ratios and trackers of collateral values.

Savvides, Savvakis (2019), “The Decoupling of Debt from Productivity (Unproductive Debt and the Impairment of the Real Economy)” John Deutsch International Development Discussion Paper, Queen’s University, DDP 2019-10:

The below are quotes from the paper. Headings and text in brackets have been added for clarity. The below summary serves to characterize unproductive debt as a concept for macro trading only. It does not imply any endorsement of the broader political or economic policy views of the paper.

What is unproductive debt?

“Unproductive debt…[arises from] lending on the basis of collateral rather than on a proper assessment of the ability to repay…Current bank wisdom dictates that [if] the collateral is considered to be ‘sufficient’ security there is no need to worry about the repayment…This logic is, however, misplaced, not only for the [overall] economy but also for the banks themselves as the value of the collateral itself is affected by deteriorating market conditions and financial crises.”

“From the point of view of economic development, the proper role of banks is…to prudently assess and guide debt finance into productive investments… A productive investment is defined as one where it is adding to the net wealth of the economy… Finance that is not invested in viable projects and businesses does not generate sustainable economic development.”

A capital investment project when appraised for the economy through cost-benefit analysis should have a positive net present value where the net cash flows of the project discounted at the opportunity cost of capital is higher than zero. A viable investment should also be expected to service the debt it undertakes… In other words, any new investment project should have a manageable risk profile and the decision on whether to undertake and provide the financing for it should depend on the outcome of this risk analysis.”

“Sustainable economic development therefore can only be attained if capital investment and financing is channelled towards funding the most viable and therefore also competitive projects…Where the priority is to contain or even eliminate investment risk while attaining a good return, inevitably the end result is not wealth creation but wealth extraction. This is because only in situations of forced wealth transfers can one hope to find such conditions of a return without the risk.”

“If banks lend only with respect of their own security (guarantees and collaterals available) considerations rather than by prudently assessing the project’s or business’ ability to repay, then debt can become wasteful and extractive. Such lending, if done in excess, leads to financial bubbles and cause economic crises.”

The connection to systemic risk?

“What is not widely understood is that without the expansion of the money supply through debt it would not be possible to pay the interest accrued. Therefore, if one starts out from the premise that all debt and interest must be repaid, there is really no choice but to continue pumping more debt into the economy. Strange as it may sound, in conditions of excessive debt, more debt is what provides the funding necessary to pay the accrued interest. However, the more lending that is injected into the economy the greater the need for the existence of potentially viable investments so as to generate value-added and result in real economic growth.”

Debt has continued to grow since the financial crisis of 2008…The International Monetary Fund reports that global debt reached an all-time high of USD184 trillion in nominal terms or the equivalent of 225% of GDP in 2017…on average, the world’s debt now exceeds USD86,000 in per capita terms, which is more than 2½ times the average income per-capita… the proportion of debt to GDP in advanced economies is fast reaching the point that would be considered not repayable…on average at 266% in 2017.”

“Corporate debt, in particular, is increasing at rates which are higher than the GDP growth of most developed countries…Developed economies have built up very highly leveraged corporations. The rising debt to gross operating surplus (GOS) ratio in these countries suggests that corporations are increasingly depending more on debt for their funding and that the repayment of this growing debt is depleting equity in the real economy… Existing unrepayable debts deplete the equity (or net worth) position of firms and households.”

In the cases of the United States and the United Kingdom…government debt has about doubled since the 2008 financial crisis…If one compares the level of government debt in 2017 to what it was in the year 2000 the increase is closer to 400% (376% and 443% for the US and UK respectively).”

Indicators of unproductive debt

“Real growth in developed countries, even under normal circumstances (where the economic agents are not heavily indebted), can at best only grow on an approximately linear path. [A] gap [between the expansion of debt and a plausible path of the real economy] creates bubbles and financial crises with the lingering debt hampering the recovery of the real economy.”

Explosive and out-of-control growth of debt ends up being directed increasingly towards wasteful spending and into wealth extraction activities that benefit the few rather than in creating new wealth for society at large.”

“The promise of a return without risk leads financial intermediaries to direct funding towards the capture of existing assets rather than being invested back in the real economy to create new wealth.”

Concentration of money and power breeds inefficiency and inequality and leads to a misallocation of economic resources. Those financial intermediaries handling a huge accumulation of funds (pensions and private wealth) inevitably promise a safe and high return to acquire the management of these funds. The only way to deliver on that promise, however, is through acquisition of existing and often distressed assets (wealth transfer) rather than investing in the creation of new wealth.”


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