[MUSIC] The famed Victorian playwright Oscar Wide once proclaimed that he could quote, resist everything except temptation, unquote. In finance, there is one temptation that trumps all others. That is the temptation to borrow money. And that temptation has been growing stronger and stronger around the world. This chart explains one of the reasons why this is the case. The chart tracks average interest rates on long-term government loans for the last half century. The lower the interest rates, and we are at historic lows right now, the lower the price of money. Meaning the cost of borrowing is really low. So these days money is on sale. And at such low prices, who can resist buying? For many, these conditions are just too tempting. Much like a blow out sale in your favorite store. But as is the case with any sale where the prices seem almost too good to be true, you have to wonder about the quality of the merchandise. It was not long ago that millions of Americans were tempted to take out mortgage loans they couldn't afford, in order to achieve the dream of home ownership. And so many financial institutions were happy to lend this money that we ended up with the 2007 financial crisis. These sorts of predatory lending practices were crucial to creating the conditions that led to the crisis. And in an effort to prevent the similar situation in the future, most jurisdictions have now legislated against these practices which include low sub prime mortgage rates, pre-approved loan applications and overgenerous terms of credit. But a bigger lesson is that we don't really need all of these enticements. All on its own, debt is extremely tempting. And one can always find good reasons why we find ourselves into debt. When we discussed bonds, for example, in course two on markets, we identified conditions that resulted in excessive debt back in 1436. This was an historic moment in Italy, in a place called Monte Comune, which literally means mountain of debt, that gave rise to the remarkable invention of bonds. When citizens complained about paying too many taxes, the government created the first public bond issue, a repackage way of citizens to give their money to the government and people invested voluntarily. From then on bond markets have open doors to increasing social prosperity That would otherwise have been unimaginable. In the public sector, for example, bonds have provided a vital long term source of money to governments to pay for major undertakings like warfare and large scale infrastructure projects. Today, bonds are increasingly used to bail out government from bloated expenditure obligations that are necessary to meet societal needs. And in the US for example, just to expenditures, social security and healthcare, made up about half of the US government budget last year. Though bond are typically viewed as safe investments, there's risk involved as well. As any one who owned investments in 2007 knows very well. Bond markets can be time bombs that destroy borrowers, no matter what their reputations has been in the past, once your ability to borrow or debt capacity is used up. This happens when there isn't enough cash flow to meet required payments to bond holders. This can ultimately result in the worst case scenario, which is bankruptcy. As we saw in course two, Markets, the video on turbulence, time and again the same chain reaction resurfaces during every major documented financial crisis. Cheap money is followed by a rapid expansion of credit and an accumulation of debt in various sectors of the economy, every single time. indeed, a critical point was made in the first course, Decisions, and it is worth reiterating. The single best predictor of a market failure, and the most important trigger for market self-destruction, is too much debt. Now this is not meant to make you panic, liquidate your assets into cash, and hide it all under your mattress. But it's worth pointing out that all of the conditions I've just described do exist today. According to the McKenzie Global Institute report, worldwide debt of all types grew by $57 trillion from 2007 to 2014. There is now 199 trillion in worldwide debt. And that in the same time it took me to say that sentence, it's likely that millions more have been added to the total. As you can see in this chart, that debt level is now equivalent to 286 percent of global GDP in 2014 compared with 269 percent in 2007. Which was the year that started the great recession. Now in in 2016 that ratio has surpassed three hundred percent. And one of the scarier facts about these numbers is that the fastest rising segment of world wide debt is actually government debt. How are you feeling about these bonds now? In this next chart which depicts change in the debt to GDP ratios from 2007 to 2014, we can see the debt to GDP ratios have risen in all advanced economies. In the sample some even by more than 50%. In the case of China for example, debt has quadrupled while its growth rate slows, which challenges us to imagine more broadly how the global economy will sustain this magnitude of world wide borrowing. Given these larger trends, it won't surprise you to learn that governments are not alone in their aggressive borrowing habits. The household and private sectors also show significant increases in borrowing as well. All in all, it definitely appears that we have reached dangerous levels of debt across all sectors of the economy. However, simply recognizing this is not enough to prevent another debt driven crash. If we want to do something to change our situation. We need to better understand what's really behind the great temptation to borrow. And we need to do that from all vantage points. Including those of individuals, of firms, and of governments. More importantly we need to consider a range of decisions and actions that may help us to properly prepare for a repeat of the history we know so well from the time of Monte Commune in the 15th century. An implosion of debt markets is likely but it's impossible to predict exactly when this is going to occur. Or for that matter how severe the impact will be. Rather than bury our heads in the sand, let's use this time to get prepared.
