Standing before an auditorium at the University of Hong Kong earlier this year, International Monetary Fund Managing Director Christine Lagarde praised what she saw as a “strong upswing that holds the promise of higher incomes…
Standing before an auditorium at the University of Hong Kong earlier this year, International Monetary Fund Managing Director Christine Lagarde praised what she saw as a “strong upswing that holds the promise of higher incomes and living standards” around the world.
But she also warned that the good times won’t last. In order to shelter the world from a future international economic crisis, she advised nations to prioritize fixing “the roof while the sun is still shining,” pointing to the record $164 trillion in public and private debt currently amassed by nations.
Ten years have passed since the financial services firm Lehman Brothers filed the largest bankruptcy in history, an event that pushed the world’s financial systems to near collapse and countries’ economies to crisis. While many countries today stand on considerably sounder economic footing than they did 10 years ago, a cloud of debt darkens the futures of major economic players like the U.S. and China, as well as emerging market and developing nations running hefty tabs.
The sheer scope of global indebtedness has many experts concerned about a future debt-fueled crisis.
“Public debt in advanced economies is at levels not seen since the Second World War. And if recent trends continue, many low-income countries will face unsustainable debt burdens,” Lagarde warned in her Hong Kong speech, cautioning that “high debt in low-income countries could jeopardize development goals” and that “high debt burdens have left governments, companies and households more vulnerable to a sudden tightening of financial conditions.”
Recovery throughout much of the world has been modest but steady in recent years — a trend expected to continue in the near future. The World Bank projects the global economy will expand at a respectable 3.1 percent in 2018, 3 percent in 2019 and 2.9 percent in 2020.
Despite this relative economic health, however, few world leaders have in recent years found debt reduction measures politically palatable, running up steep obligations that sooner or later will need to be repaid.
There are several ways to measure the world’s current level of indebtedness, but it’s difficult to find data suggesting obligations haven’t mounted considerably in the aftermath of the global financial crisis. In 2010, the ratio of debt-to-gross domestic product, or GDP, in the average country belonging to the Organization for Economic Cooperation and Development stood at 71.7 percent. By 2016, that average had climbed to nearly 86 percent. The figure excludes Colombia and Iceland where complete data is unavailable.
Meanwhile, analysts at the Institute of International Finance estimate the debt held by the governments, households and companies in leading industrial nations — along with many emerging and developing economies — collectively climbed by more than $8 trillion during the first three months of 2018. The total international debt eclipsed $247 trillion, up more than 11 percent on the year, to set a new international record.
“While a high debt burden isn’t necessarily a problem by itself, it increases the vulnerability of the system to a shock — in particular, a shock that would lift interest rates,” Jeffrey Kleintop, a senior vice president and chief global investment strategist at Charles Schwab & Co., wrote in an August research note. “In theory, all that debt means the potential losses from a rise in interest rates would be more costly than in the past, especially combined with a stronger dollar pushing up the cost of dollar-denominated debt outside the United States.”
Many countries drove themselves into debt for legitimate reasons. Some found themselves spending to simply pull their economies out of the red. The U.S., for example, eventually authorized $840 billion — through the 2009 American Recovery and Reinvestment Act and a second stimulus package passed by Congress in 2012 — to go toward recessionary recovery. Officials at the Federal Reserve Bank of St. Louis estimate America’s debt-to-GDP ratio ballooned an average of 6.2 percentage points per year between mid-2009 and mid-2012.
Others seized on low interest rates in the U.S. and Europe to more affordably borrow money, fueling domestic growth. Many emerging market economies took on dollar-denominated debt before the Federal Reserve began raising its benchmark interest rate back in late 2015. The Institute of International Finance estimated earlier this year that emerging market governments and companies hold nearly $3 trillion in dollar-denominated debt that will need to be repaid in the coming years.
Other countries have relied on debt issuance to help fund infrastructure projects to either bolster their own economies or better connect them with trading partners — though projects fueled by unsustainable infrastructure debt have drawn international ire in recent months. More than a dozen U.S. senators earlier this year took issue with debts incurred by developing nations as part of China’s Belt and Road Initiative, writing in a note to senior officials in President Donald Trump’s administration that China was engaging in “debt-trap diplomacy” by backing projects in poorer nations that are saddling them with unpayable debts.
The U.S. lawmakers cited an estimation from the Center for Global Development that found 23 of 68 countries currently hosting Belt and Road Initiative projects are “at risk of debt distress today.” They also cited Djibouti and Sri Lanka as countries that have been forced to grant China “onerous concessions, including equity in strategically important assets” in an effort to get out from under their indebtedness to Asia’s largest economy.
Debt isn’t inherently toxic to individual economies — especially if it is taken on in controlled levels that either help boost growth or avoid stretching a country beyond its means. Worries about the impact debt will have on a new financial crisis are growing, particularly now that the U.S. Fed is raising its benchmark rate in an effort to normalize monetary policy and add ammunition to its arsenal should the U.S. again fall into recession. In effect, that’s making dollar-denominated debt more difficult to repay.
Exacerbating the problem is investor flight from long-attractive emerging market investments and into safer havens such as the U.S. dollar — strengthening the greenback further against emerging-market currencies. The recent economic woes in Argentina and Turkey, for example, are deeply rooted and sprout from several political and economic factors — but experts believe both countries have been adversely impacted by a stronger dollar, higher U.S. interest rates and weaker domestic currencies.
“Signs of strain, or outright crisis, have been seen in emerging markets around the world in recent weeks, including Turkey and Argentina,” Mark Hamrick, a senior economic analyst and Washington bureau chief at Bankrate.com, wrote in a research note earlier this month. “The strength of the dollar, contrasted with weakening foreign currencies, are signs (and causes of) of further strain around the globe.”
But larger, more established economies have hardly shied away from taking on debt in recent years. Analysts at the IMF in 2016 estimated the U.S. ($48.1 trillion), China ($25.5 trillion) and Japan (18.2 trillion) accounted for more than half of the world’s total indebtedness. Global debt held by governments, households and non-financial firms reached an all-time high of $164 trillion that year, fueled largely by those three countries.
China, in particular, stands out as helping fuel that record debt burden. According to the IMF, Beijing’s share of global debt climbed from 4.2 percent in 2007 to 15.5 percent in 2016 — nearly quadrupling over the span of nine years. The U.S. is still the most indebted country in the world, accounting for 29.3 percent of global debt. But America’s debt burden in recent years hasn’t grown nearly as quickly as its Asian economic rival.
“One of the bigger risks for the global economy are developments in China,” Bank of England Governor Mark Carney said in a recent interview with the BBC. “The level of debt is enormous relative to the size of the economy.”
The interconnected nature of international debt has made it difficult to predict which country — or group of countries — sets off the first domino potentially leading to another global crisis, amplifying global focus on countries such as Turkey and Argentina that already appear to be struggling. But addressing an individual nation’s debt burden often involves politically unpopular actions from world leaders — potentially scaling back government spending and support programs or raising taxes to bolster the savings that can go toward paying down existing obligations.
In many countries grappling with a global rise in populism and dealing with contentious election cycles, prioritizing long-term debt obligations over short-term popularity points is viewed by some as a risky proposition.
“This generation of policymakers is facing a stark choice,” Lagarde said, warning that “policies of the past” have “delivered mixed results.” She added: “We certainly need more courage — in the halls of government, in company conference rooms and in our hearts and minds.”