LONDON, Oct 3 (Reuters Breakingviews) – The 2008 global financial crisis was supposed to have taught the world the dangers of excessive debt. But borrowing has increased since then. Government, corporate and household debt accounted for 195% of global GDP in 2007, according to the International Monetary Fund. By the end of 2020, it had reached 256%.
These mountains of debt are harder to bear as interest rates rise to stifle inflation, the Covid-19 pandemic and energy crisis have hampered growth, and investors are more risk averse. This will lead to economic tensions, especially in Europe, China and the Global South, poisoning domestic politics and geopolitics.
The debt has increased for three main reasons. First, governments bailed out the financial system. Then they supported households and businesses during the pandemic. Now they are cushioning the blow of exorbitant gas and electricity prices.
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QE DEBT VALUATION
Cheap money allowed these follies. In the West, this took the form of quantitative easing (QE), where central banks bought government bonds and other assets. While they were right to use QE to avoid economic collapse, cheap money has been a painkiller. Many governments have stopped worrying about balancing their books. Corporates and emerging markets also benefited from leverage.
If the borrowers had used the money to finance productive investments, it might not have mattered. But instead, they spent much of it on unproductive investment or consumption.
Excess housing construction in China is the best example of unproductive investment. The country’s debt as a share of GDP has doubled since 2007, according to the IMF. This is suffocating its economy and is one of the reasons the World Bank just cut its growth forecast for China this year from 5% to just 2.8%.
Meanwhile, the massive support operations of European governments during the pandemic and the energy crisis are a classic example of borrowing to finance consumption. Politicians have made little effort to target subsidies to the most vulnerable.
The low productivity of this loan is visible in the data. Over the past decade, global debt has increased by $90 trillion, while GDP has grown by only $20 trillion, according to Sonja Gibbs, who leads the debt policy work of the Institute of International Finance (IIF).
Artificially cheap money also encouraged risky behavior. Investors have used leverage to help them seek higher returns, while funding long-term assets with short-term borrowing. The UK pension fund industry, which actually received a bailout from the Bank of England last week, is a case in point. An example of this is the British practice of financing house purchases with floating or fixed interest rate mortgages for short periods. More problems are sure to emerge now that the era of cheap money is coming to an end.
It’s not just central banks that are raising interest rates in a belated attempt to contain inflation. So-called “bond vigilantes” — bond investors who impose discipline on debauched borrowers — are awakening from their long slumber.
The sharp fall in British sovereign bonds last week before the BoE’s intervention is the first major sign of this in the rich countries. Investors have lost confidence in Liz Truss, the new British Prime Minister, because she is borrowing to cut taxes as well as to protect consumers from high energy prices; and because Brexit had already hurt the country’s economic prospects.
But Truss’s willingness to take the risk is proof that a generation of politicians grew up thinking there are few consequences to rising debt. They are afraid that the voters will kick them out if they balance their budgets. Central banks fear deepening recessions and causing financial crises if they tighten monetary policy too much. But if central banks become government minions, investors will go wild.
It’s not just the UK that’s in danger. Italy and Greece are particularly vulnerable due to their high debt-to-GDP ratios. If investors conclude that these are unsustainable, the euro itself could come under further strain.
OUR MOTTO, YOUR PROBLEM
Compared to others, the United States has some protection against this problem. Shale gas reserves make it a relative winner in the energy crisis. And the rising dollar will help it stop inflation faster than other countries.
But the strong greenback is making life harder for almost everyone. It drives up inflation in the rest of the world and adds to the distress of those who have borrowed in dollars. It’s been more than 50 years since the then US Treasury Secretary told his counterparts that “the dollar is our currency, but it’s your problem”. The adage is still relevant today.
We are in the early stages of a new debt crisis in the countries of the South. Poor countries are particularly vulnerable to high food and energy prices. Investors’ heightened risk aversion is also hitting them hard. The spread between high-yield dollar sovereign debt and U.S. Treasuries is now over 10 percentage points, about double what it has been for most of the past decade, according to the IIR.
Sri Lanka, Ghana, Egypt and Pakistan have already requested IMF assistance for their debts. According to an IMF article, around 60% of low-income countries are in debt distress or at risk of it. So far, it’s not as bad as the Latin American debt disaster of the 1980s, which also infected Africa, or the East Asian crisis of the late 1990s, who coached Russia and Brazil. Moreover, major Western banks have less exposure to emerging markets than they did in the 1980s. But the flip side is that the debt is spread among many bond investors and China is a massive lender. This fragmented creditor base makes it more difficult to restructure countries’ borrowings: no lender wants to suffer the consequences if they are not convinced that others will share the pain.
Poor countries may explode in anger as they feel victimized by the actions of rich countries. They didn’t flood the world with cheap money, they didn’t get many vaccines to deal with the pandemic, they didn’t cause the food or fuel crises – and they aren’t responsible for the climate crisis affecting their countries. particularly badly. Nevertheless, like in Europe and China, the problems caused by more than a decade of seemingly free money are now coming home.
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Editing by Peter Thal Larsen and Oliver Taslic
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