What's the solution for a global economy addicted to debt? More debt
Cheap borrowing costs have sent global debt to another record
Crippling student bills in America; sky-high mortgages in Australia and another default scare in Argentina. A decade of easy money has left the world with a record $250 trillion (Dh918.29tn) of government, corporate and household debt. That’s almost three times global economic output and equates to about $32,500 for every man, woman and child on earth.
Much of that legacy stems from policymakers’ deliberate efforts to use borrowing to keep the global economy afloat in the wake of the financial crisis. Rock bottom interest rates in the years since has kept the burden manageable for most, allowing the debt mountain to keep growing.
With central bank rates at their lowest levels and US Treasuries at their richest valuations in 100 years, we appear to be close to bubble territory, but we don’t know how or when this bubble will burst.
Anna Richards, Fidelity International
Now, as policymakers grapple with the slowest growth since that era, a suite of options on how to revive their economies share a common denominator: yet more debt. From Green new deals to modern monetary theory, proponents of deficit spending argue central banks are exhausted and that massive fiscal spending is needed to yank companies and households out of their funk.
Fiscal hawks argue such proposals will merely sow the seeds for more trouble. But the needle seems to be shifting on how much debt an economy can safely carry.
Central bankers and policymakers from European Central Bank President Christine Lagarde to the International Monetary Fund have been urging governments to do more, arguing it’s a good time to borrow for projects that will reap economic dividends.
“Previous conventional wisdom about advanced economy speed limits regarding debt to GDP ratios may be changing,” says Mark Sobel, a former US Treasury and IMF official. “Given lower interest bills and markets’ pent-up demand for safe assets, major advanced economies may well be able to sustain higher debt loads,” he adds.
Rising expectations of fiscal stimulus measures across the globe have contributed to a pickup in bond yields, spurred by signs of a bottoming in the world’s economic slowdown. Ten-year Treasury yields climbed back above 1.80 per cent earlier this week, while their Japanese counterparts edged up closer to zero.
A constraint for policymakers, though, is the legacy of past spending as pockets of credit stress litter the globe.
At the sovereign level, Argentina’s newly elected government has promised to renegotiate a record $56 billion credit line with the IMF, stoking memories of the nation’s economic collapse and debt default in 2001. Turkey, South Africa and others have also had scares.
As for corporate debt, American companies alone account for around 70 per cent of this year’s total corporate defaults even amid a record economic expansion. And in China, companies defaulting in the onshore market are likely to hit a record next year, according to S&P Global Ratings.
So called zombie companies — firms that are unable to cover debt servicing costs from operating profits over an extended period and have muted growth prospects — have risen to around 6 per cent of non-financial listed shares in advanced economies, a multi-decade high, according to the Bank for International Settlements. That hurts both healthier competitors and productivity.
As for households, Australia and South Korea rank among the most indebted.
The debt drag is hanging over the next generation of workers too. In the US, students now owe $1.5tn and are struggling to pay it off.
Even if debt is cheap, it can be tough to escape once the load gets too heavy. While solid economic growth is the easiest way out, that isn’t always forthcoming. Instead, policymakers have to navigate balances and trade offs between austerity, financial repression where savers subsidise borrowers, or default and debt forgiveness.“The best is to grow out of it gradually and consistently, and it is the solution to many but not all episodes of current indebtedness,” said Mohamed El-Erian, chief economic adviser to Allianz.
Policymakers are ploughing on in the hope of such an outcome.
To shore up the US recovery, the Federal Reserve lowered interest rates three times this year even as a tax cut funded fiscal stimulus sends the nation’s deficit towards 5 per cent of gross domestic product. Japan is mulling fresh spending while monetary policy remains ultra easy. And in what’s described as Britain’s most consequential election in decades, both major parties have promised a return to public spending levels last seen in the 1970s.
China is holding the line for now as it tries to keep a lid on debt, with a drip feed of liquidity injections rather than all out monetary easing. On the fiscal front, it has cut taxes and brought forward bond sale quotas, rather than resort to the spending binges seen in past cycles.
As global investors get accustomed to a world deep in the red, they have repriced risk — which some argue is only inflating a bubble. Around $12tn of bonds have negative yields.
Anne Richards, chief executive of Fidelity International, says negative bond yields are now of systemic concern.
“With central bank rates at their lowest levels and US Treasuries at their richest valuations in 100 years, we appear to be close to bubble territory, but we don’t know how or when this bubble will burst," she adds.
The IMF in October said lower yields are spurring investors such as insurance companies and pension funds “to invest in riskier and less liquid securities,” as they seek higher returns.
“Debt is not a problem as long as it is sustainable,“ says Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis in Hong Kong, who previously worked for the European Central Bank and Bank of Spain. “The issue is whether the massive generation of debt since the global financial crisis is going to turn out to be profitable.”
Published: December 5, 2019 08:00 AM