Global debt overhang

Global debt continues to grow steeply  with no end in sight now hitting a record high in the first half of this year. According to the Institute of International Finance (IIF), global debt surged to US$250.9 trillion in the first half of this year (2019) led by high levels of borrowing by the US and China and this amount  will exceed US$255 trillion by the end of the year. This figure same time last year was US$243.6 trillion.

The report further highlighted that global debt increased by US$ 7.5 trillion in the first six months of 2019; and the US and China accounted for over 60 per cent of this increase.  However, the absolute value of global debt is not a very informative figure, it is debt as a percentage of  GDP (gross domestic product) that helps us to get the clearer picture. This is already a record figure which represents 320 per cent of global GDP.

The ever-increasing level of debt threatens economic growth. It is also of serious concern for investors. Debt is now much higher than what it was before the GFC (2007-08 Global Financial Crisis), making the global economy vulnerable to economic and market shocks and that may trigger another financial crisis. The debt to GDP ratio was 208 per cent in 2008 now rising to 320 per cent. Even a year before in 2018 the ratio was 234 per cent, a record rise of 86 percentage points in just one year. Record low interest rates are fuelling the borrowing binge by corporations and governments and there is no sign of slowdown in the pace of borrowing. Of the total debt, 24 per cent are financial debt, 27 per cent are government debt and 49 per cent are non-financial corporate and household debt. So it is non-financial private debt that dominates the global debt overhang.

While market analysts are not overly pessimistic about any credit crunch or a financial crisis, they also recognise that global debt is higher and in many instances riskier than a decade ago. It is also suggested that the increased debt levels have been largely driven by advanced economies like the US's government debt and domestic-funded Chinese corporate debt thus mitigating any contagion risk. Chairman of the Federal Reserve also is not very worried about the rising debt level and also does not see any  bubbles brewing. Low interest rates lower debt servicing costs which allowed many countries to sustain higher debt/GDP ratios without eliciting any negative reaction from financial markets.

Now some economists are in fact canvassing increased government spending without increasing taxes to increase social spending to stimulate the current phase of economic stagnation. They argue that deficits (public borrowing) are harmless if twinned with low inflation.  The proponents of so-called Modern Monetary Theory (MMT) further argue that policy makers in countries (such as the US) that print their own currency can take on as much debt as necessary to keep the economy at a steady growth path with full employment. Oliver Blanchard, the former IMF Chief Economist, argued at a gathering of economists that fiscal policy be given greater emphasis now that interest rates appear to be persistently low and below the annual growth rate of nominal GDP (implicitly arguing for deficit spending). He then further added that the world was shifting to more normal period where growth rates exceeded long-term risk free interest rates.

Kenneth Rogoff of Harvard University questioned the very basis of MMT policy that interest rates and inflation would stay low for long time making public debt much less expensive. Larry Summers also questioned that public debt can always be financed by printing money without triggering inflation. He described the MMT proposition as "offering false promise of a free lunch''. He then emphasised that Washington should end its debt obsession.

But as the scope for further easing of monetary policy is getting narrower as countries with high levels of debt, some developed and other emerging market economies, may find it harder to turn to fiscal stimulus. This is the general view of the IIF. It further points out that the big increase in global debt over the last decade has been driven by governments and the non-financial corporate sector. The reason for the rise in global debt levels, according to the IIF, is  buoyant global bond market. Investors are increasingly looking for safer assets like  US Treasury bond amid global uncertain economic environment.

Low interest rates are also encouraging corporations to take on larger loans. Non-financial Corporate debt now stands at more than 40 per cent of total debt and this debt is largely concentrated in limited number of highly industrialised developed countries and China. Falling interest rates and quantitative easing (QE) have also subsidised an enormous build-up of debt  without corresponding increases in interest payment. This has encouraged corporations to carry on much higher levels of debt to go for leveraged buyouts and stock buybacks.

The IMF (International Monetary Fund) is increasingly pointing out that the levels of debt corporations piled up in these countries now pose a danger. It further points out that it would be impossible for these corporations to service the debt if there was economic slump half as bad as one occurred a decade ago, alluding to the GFC. The risk is now increasingly becoming more apparent in non-financial private sector where debt owed by firms and households would not be able to make interest payments with their earnings. Also, at some points interest rates will inevitably rise for a variety of economic reasons and that will make the situation even far more worse.

The fact of the matter is: debt that cannot be paid, won't be paid.  When debtors default, creditors are nowadays kept afloat by providing an artificial life support by means of money creation by the central bank to bail out banks and bond holders. That is what Quantitative Easing (QE) is all about. The QE will also continue creating abundant supply of cheap money. This will lead to build-up of further debt burden with significant potentials for destabilising the financial system again.

The subprime crisis  and the underlying financial crisis were largely manufactured in the US which then spread around the world. The policy response in the US to the crisis was to undertake a massive public-funded rescue mission abandoning the firm belief in self-regulating capacity of the market. This was possibly the biggest socialisation programme in the recent economic history of our time. It was indeed a very unique socialisation programme in a counter-intuitive sense where massive amount of money was redistributed from the poor to the very rich.

 Meanwhile, firms and households are also forced to deleverage to meet their debt obligation. Deleveraging by households lead to decline in household consumption demand. That in turn leads to decline in private corporate investment. All put together cause economic slump needing increased public expenditure to keep the economy moving. This is indeed a typical counter cyclical policy measure causing public debt to rise. But this resort to debt financing by government in response to the crisis has not resulted in a robust recovery or helped to resolve the non-financial private debt problem.

All in all, the specific way in which the Global Financial Crisis was sought to be addressed - that is, a reassessment of fiscal policy as reflected in central banks' liquidity injections through quantitative easing, a prolonged period of very low to negative interest rates and  the absence of inflationary pressure - failed to reinvigorate the economy. And more worryingly, failed to promote inclusive growth. The policy as pursued disproportionately benefitted the rich and also caused a debt spiral.

Muhammad Mahmood is an independent economic and political analyst.

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