Financial crisis 2.01

Robert Samuelson

Robert Samuelson

WASHINGTON, DC: While everyone fixates on the US election, developments in the world economy threaten to create problems for the next president and, possibly, trigger a major financial crisis. A little-noticed study by the International Monetary Fund (IMF) delivers the bad news. It finds that global debt — including the debts of governments, households and non-financial businesses — reached a record $152 trillion in 2015, an amount much higher than before the 2008-09 financial crisis.


What’s worrisome about this is that the global economic recovery has assumed widespread “deleveraging” — the repayment of debt by businesses and households. Initially, the theory went, these repayments would slow the economy. To reduce their debts, households would cut consumption and companies would cut investment. But once debts had receded to manageable levels, consumer and business spending would bounce back. The economy would accelerate.

It hasn’t happened. With a few exceptions, little deleveraging has taken place, the IMF shows. One exception is the United States, where there has been some deleveraging among households. But generally, just the opposite has occurred. Many countries have become more indebted. On a worldwide basis, the $152 trillion of debt (again: both private and governmental) is up from $112 trillion in 2007, before the financial crisis, and $67 trillion in 2002.

Recall that the pre-crisis economy relied on debt-driven growth. People and firms could spend more, because they’d borrowed more. This was not just true in the United States with its housing bubble. Borrowing financed housing booms in Europe (Spain and the United Kingdom), consumer goods and investments in factories and machinery. Government debt has played a bigger role since the crisis, but private debts — borrowings by firms and people — represent two-thirds of all debt.

Still, debt-driven growth has limits. The more that is borrowed, the more likely that borrowers, lenders — or both — will pull back, further undermining economic growth. The IMF study fears “a vicious feedback loop”: High debts discourage more borrowing. A slowing economy then makes it harder to repay debts. Deleveraging is stymied. This is a pervasive dilemma. Private debt is “high not only among advanced economies” but also in many emerging-market countries (China, Brazil).

These fears, of course, may be overblown. Economist William Cline of the Peterson Institute, a think tank, notes that although debt is high, interest rates are low. What matters for borrowers is how easily they can service their loans by paying interest, and low rates clearly help. “Compared to the early 1980s, when interest rates were very high, there may be more space for higher debt levels,” says Cline.

A report from the bond rating agency Moody’s makes a similar point about business. “Like homeowners, companies can afford larger loans at low rates,” the report says, “and since debt markets are flush with cash, few [borrowers]get turned down.” The extra cash may be a cushion against a future crisis.

Also, there isn’t any magic threshold beyond which a country’s debts automatically become unsustainable. It depends on the country and on circumstances. Japan’s private and governmental debts equaled 416 percent of its economy (gross domestic product) in 2015, a level — in relation to GDP — almost two-thirds higher than the United States’. Yet, Japan’s debts have not caused a financial crisis. (Nor, it must be added, have they fixed the economy’s underlying problems.)

Perhaps societies can operate with debt levels that once were considered imprudent. Or perhaps such debt will prove, as with America’s housing bubble, a mirage that bursts destructively. What’s called the “debt overhang” is already acting as a drag on the world economy, says Hung Tran of the Institute of International Finance, an industry research group. Much evidence supports his view.

Whether or how this might become a full-blown crisis is uncertain. Economist Desmond Lachman of the American Enterprise Institute, another think tank, says that the private debt of companies and households in China has inflated faster than the US housing bubble. “China has been an engine for global growth,” he says. “Now it’s sputtering.” The Bank for International Settlements in Switzerland worries that some emerging-market firms won’t repay dollar loans.

To increase economic growth, some economists urge more “infrastructure” spending on roads and ports by countries that can still borrow. This might help, but a little arithmetic suggests that the potential is limited. The world economy is about $75 trillion. Boosting growth by 1 percentage point would require $750 billion in extra annual spending. Does that seem likely?

The next president cannot escape these issues. Compared to many countries, the United States survived the Great Recession in relatively good shape. But we are inevitably affected by the broader global economy. The delay of deleveraging suggests a slowing world economy and a continued political backlash against global trade and investment.



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