Tsunami of Global Debt

In a publication called: “Global debt Monitor: Attack of the Debt Tsunami” on November 18, the Institute of International Finance reported that the global debt would reach an all-time high of $277 trillion. That is with 12 zeros, over $15 trillion more since the end of 2019 and 365% of the World’s Gross domestic product (GDP)! Even though debt has increased drastically in the previous decade since the 2007-2008 economic crisis, it has never increased to such heights in the space of a year.  

These are the numbers according to the Institute of International Finance (IIF):

  • China’s debt reached 335% of GDP in 3rd quarter of 2020
  • US debt will reach $80 trillion, an increase of $9 trillion from 2019
  • The Eurozone debt will reach $53 trillion
  • Debt reached 432% of GDP among advanced nations in the third quarter of 2020.
  • Debt reached 248% of GDP among emerging markets, a rise of 26% to GDP
  • Lebanon, Turkey, China and Malaysia have seen the biggest rise in non-financial-sector debt

“The pace of global debt accumulation has been unprecedented since 2016, increasing by over $52 trillion,”

IIF

The problem with this debt is not only that the pandemic induced recession pushed governments, corporations and households to borrow but that it is growing from a heap since the last recession of 2007-2008. Further, the accumulation of debt in 2020 has not helped in the recovery of the countries economy but has rather been put to less productive uses; such as corporate bailout like in the airline industry and payments on principal and interest from already existing debts.

“Largest, fastest, and most broad-based wave yet.”

According to the report by the World bank entitled Global Waves of Debt, the global economy has experienced four waves of debt accumulation over the past fifty years. The fourth one is the one we are in right now.

  • The first wave ran from the 1970s to the 1980s. Governments in low-income and Latin America countries borrowed heavily from the US commercial banks and other creditors. This is because there were low interest rates, a rapidly growing syndicated loan market and their economy were thriving. It ended up with a series of crises in the early 1980s, the debt level and interest payments became unsustainable.
  • The second wave ran from 1990 to the early 2000s. With many developed nations deregulation their financial market called the Capital market liberation. On one hand, private sector debt played an important role in the debt accumulation with a surge in capital flow. On the other hand, emerging economies mainly in Asia became very dependent on borrowing to fuel their economies. A currency crisis in Mexico lead investors to do a U-turn on their capital flow by 1997. Countries with significant amount of debt like the Philippines, Thailand and Malaysia fell into economic downturns.
  • The third wave ran from 2002 to 2009. With massive deregulation in developed economies that paved the way for creation of “mega-banks” and an increase in private sector borrowing. Defaults in the US subprime mortgage system lead to a crisis in the financial sector that lead to what is commonly referred to the great recession.
  • The fourth is described in the report as the “Largest, fastest, and most broad-based wave yet.” It started in 2010 and is still ongoing. The report notes that:
  1. “The current wave of debt accumulation bears many resemblances to the three previous waves.”
  2. “It has been different from the previous episodes in terms of the size, speed and reach of debt accumulation”

This debt is much more global, and it reaches most countries and sectors. Further, even before the pandemic, the debt accumulation was high, and the economic growth of most countries was relatively slow compared to previous periods. This leads nations to face vulnerabilities never seen previously. Further, this amount of debt acts as an obstacle for economic development. The day where we will be back to “normal” will never come as having high level of debt comes with obligations from borrowers: the State, corporations and households. For example, a big chunk of the household income would need to pay the student loan or on the mortgage while in “normal” times, it would be used on home repair, entertainment and even leisure.

The million-dollar question is whether a crisis is looming ahead. All debt accumulation of the past ended up pretty bad. We may well end with consequences of the 3 waves combined.

Here is a breakdown of the 3 nations that contribute to over half of the global debt and their risks of default on their debt.

The United States

The US holds the first place in the amount of debt in the World. With an increase of $9 trillion this year, it is set to reach $80 trillion in total. As of the 1st of October 2020, the total debt owed by the US federal government was over $27 trillion. The debt per citizen is almost $83 000 at the time of writing. Two-thirds of this debt is held by the public. That is companies, individuals and foreign governments. The remaining one-third are intragovernmental debts. They are securities held by the various departments and the biggest one is social security.

For US households, it was already a record high before the pandemic. With interest rates already low, it stood at $14.3 trillion in the Q1 2020, way more than its previous peak during the Great recession at $1.62 trillion in Q3 2008. The total US non-financial debt jumped by 11.7% to $55.9 trillion at the end of Q1 2020.

The credit rating by DBRS (Dominion Bond Rating Service) of the United States is AAA and by Moody’s Aaa the highest rating. The billionaire Warren Buffet explains that the risks that the US government fails to meet its financial obligation is close to zero. This is simply because the US issues bonds in its own currency, the US dollar.

“If you print bonds in your own currency, what happens to the currency will be the question,”

Warren Buffet

The only problem is inflation. The government can print as much money as it needs for repayment, but the value of the currency will suffer. With it, a rise in prices which may well turn out to affect prices throughout the world because international trade is mainly conducted in USD. Therefore, the economic repercussions will have a domino effect that will affect everyone.

China

The Institute of International Finance estimates that China has an overall debt of 335% GDP as from the third quarter of 2020. However, the National Institution for Finance and Development, a Chinese government-linked think tank puts the number at 270.1%. Still, it is worth remembering that the record and transparency are poor and that there are lots of hidden debts like local government bonds which are unknown figures. Because the local governments borrow through state-owned and state-controlled financial institutions, the level of public debt remains low in comparison to other nations. A large portion of the total debt is kept within the private sector.

The non-financial sector debt stood at 245% at the end of 2019. This explains how the rapidly growing Chinese industries as well as the consumer market are financed. The largest growing segment is the household debt. It increased to 57.20 percent of GDP in the first quarter of 2020. China’s households were the world’s best savers until recently. When adjusting to household income, this is over 128%. This debt is closely tied to China’s property market in the form of mortgage. Surprisingly, credit card debt surpasses the United States’ in absolute terms. And in all of this, household debt default may rise with the economic fallout and the loss of income of lower-wage industries. Further, it is worth to note that the foreign reserve is at its lowest, estimated to be around $1.6 trillion in net assets. The reserve has greatly depleted due to its overseas investments.

Consequently, the Chinese government may not default because of its low accumulation. But, the government-owned corporations may. Still, it would not have been a problem if the world was not in a pandemic induced recession, the debt taken has primarily been to invest overseas, even high-risk investment such as ports in low-income countries. As long as the investments pay for themselves, default is not close at hand. Moreover, the Chinese economy have continuously experienced economic growth. If this trend continues, default risks may diminish.

Japan

In September 2020, the total debt of the Japanese government stood at 223% of GDP, the highest public debt level to GDP in the world. The pandemic only increased the trajectory of the Japanese government deficit. The fast ageing population push the cost of health care and social security up, hence the public debt. Nevertheless, this may not be such a big as a problem. Firstly, Japan has a negative interest rate, and this makes the mountain of debt easier to pay off. Secondly, 90% of the debt is held by Japanese themselves. Domestic banks, insurance companies, pension funds, investors and seniors have high level of savings, so can buy Japanese government bonds. Thirdly, Japan holds $3 trillion of net assets, way more than other governments.

So, do they have a high risk of default? Is the fourth wave of debt ending with default like never seen before? A crisis of monumental heights?

Answers to these questions are highly speculative. There are various opinions by economists, finance experts, billionaire investors and others on this topic. The consensus however, is that because the debt accumulation has the “largest, fastest and most broad based”, it may end with the most widespread crisis in the globalized world. We are in an episode of rapid debt accumulation and that the crisis can be triggered by only a slight change in market conditions. The spread of the virus has already reverberated across the interconnected world and anything more may be disastrous.

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