Rising global debt is increasing the risk of another financial crisis
It’s not just Greece, Puerto Rico and China. Debt is piling up around the world — stifling global economic growth and heightening the risk of more defaults and market turmoil.
World leaders are caught in a trap: More debt in the form of government and private spending is needed to stimulate today’s sluggish economies. Yet the higher the debt, the greater the danger that a pullback by creditors will trigger another financial crisis like the one in 2008.
“The post-crisis world is a world of high debt, and it doesn’t take much. It just takes a bad shock for the debt dynamics to go wrong,” warned Olivier Blanchard, the International Monetary Fund’s chief economist, as he forecast slower global growth this year, partly because of excessive debt.
“We have to be ready to see other episodes of this kind,” he said, referring to the recent Greek default that shut down the country’s banks and intensified fears of a Eurozone breakup until a new bailout was negotiated.
Although a new bailout proposal has quieted the Greek drama for the moment, a long-term solution for the euro area is hard to see. Governments have generally pursued one of two strategies since the global financial crisis, though neither has been notably successful.
Europe has largely slashed spending to get a control on government budgets, but the result so far has been minimal growth and high unemployment in Greece and some other countries.
The second approach, adopted by the U.S. and China, pumped hundreds of billions of dollars into all kinds of public projects. But growth in these economies, while better, has hardly been spectacular.
Meanwhile, central banks around the world have cut interest rates and issued unprecedented amounts of bonds to spur borrowing and spending.
The result is that by the middle of last year, total global debt — government, corporate and household — reached $199 trillion, an increase of $57 trillion from the end of 2007, according to McKinsey Global Institute. That’s about $27,500 for every person on the planet.
The rising leverage, particularly in developed economies, is all the more striking given the extensive fiscal belt-tightening, write-offs by creditors and stricter lending conditions imposed since 2008.
The trend points to the growing importance — as well as risks — of the financial sector and its entrenched role in economies. With markets around the world more integrated today than ever before, troubles in one small corner of the globe can ripple far beyond, as seen by Greece’s outsized effect on Europe or the 2008 Lehman Bros. collapse, which helped trigger the global financial crisis.
“It’s not just somebody else’s debt or liability,” said Domenico Lombardi, a global economics expert at the Center for International Governance Innovation in Ontario, Canada. Yet without an international framework for managing sovereign debt problems, he expects world leaders to lurch from one crisis to the next.
“This is one area where we have no global governance,” he said.
Lombardi is keeping a watchful eye on Italy and Spain. Despite international bailouts and some progress in restructuring their economies, government debt obligations in both countries have kept climbing and now stand well above the warning level of 120% of economic output, or gross domestic product.
Reflecting this vulnerability, their stock markets took some of the biggest hits during the escalation of the Greek crisis. They also saw spikes in government bond yields, a reminder of how much their borrowing costs and public finances are linked to international investors’ sentiment and the future path of interest rates.
In the past, waves of sovereign defaults have started with movements in interest rates. In recent years governments have financed spending by selling and buying trillions of dollars of bonds. That’s helped to hold down interest rates, fueling more borrowing.
Although no one knows how much is too much, high debt historically is associated with impaired economic growth.
No country is in bigger hock than Japan; its public debt was 235% of GDP last year, the highest in the world, according to the McKinsey institute. Most of that, though, is owed to Japanese citizens and its own government, as opposed to external or foreign creditors as in Greece’s case.
So despite its inability as yet to pull out of its long economic doldrums, the Japanese government isn’t operating in fear that investors will suddenly get nervous and run for the exits. In weighing debt sustainability, what matters is who holds the loans and the credit reputation of the borrower.
The U.S. debt picture looks stable, at least for now. Though public debt as a share of GDP rose to 89% last year, the government’s budget deficit has been shrinking and is now at a seven-year low, thanks largely to continuous job and economic growth.
U.S. bank and other corporate balance sheets are the strongest they’ve been in years. And consumers aren’t nearly as strained as before, in part, because of the foreclosures and write-offs of the last decade. Household debt-service — the share of after-tax incomes needed to pay interest and principal — is now down to the levels of the 1980s.
To be sure, America’s budget pressures will build as healthcare and Social Security obligations increase with the nation’s aging population.
And debt burdens can be expected to rise as the Federal Reserve moves to gradually lift interest rates in the months and years ahead. That means money won’t be as cheap, and governments, businesses and households around the world will need to boost incomes or cut spending to manage their debts.
At the same time, U.S. growth prospects look generally sound, especially compared with most other advanced economies. And Uncle Sam isn’t likely to have trouble finding investors to buy its bonds.
“When there are global problems, the U.S. often profits because there’s a flight to credit quality,” said Mark Zandi, chief economist at Moody’s Analytics.
Zandi’s biggest long-term concern over debt involves China, the world’s second-largest economy.
The McKinsey institute said China’s total debt has nearly quadrupled since 2007, to more than $28.2 trillion, much of that from excessive lending for real estate and related industries. The recent turmoil in Chinese stock markets, caused in part by heavy borrowing by investors, raised further questions about the country’s financial underpinnings.
Still, China’s overall debt situation is nothing like countries in Europe. China’s economy may be slowing but is still growing rapidly, at about a 7% annual rate so far this year.
The nation’s debt is fairly concentrated and has little exposure to risks from outside investors. Plus, China has more capacity than most to deal with its debt load, given the country’s unusually high saving rate of about 50%.
“It’s not just about debt level, but whether a borrower can service it,” said Andy Rothman, a China expert at Matthews Asia, the San Francisco investment firm.
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