Total worldwide debt has never been higher.
And yet, there's little sign of this current wave
retreating any time soon.
Now with the coronavirus outbreak being declared
a pandemic, governments have announced hundreds
of billions of dollars in stimulus packages
that will send debt even higher.
So, just how worried should we be if it all
comes crashing down?
Global borrowing has been growing rapidly,
so rapidly that many are concerned it is quickly
becoming unsustainable.
The Institute of International Finance estimates
total worldwide debt, which is made up of
borrowings from households, companies and
government, surged to a staggering $253 trillion
at the end of September 2019.
That’s a whole lot of debt, more than three times
the annual economic output of the entire world.
It works out to roughly $32,500 of debt
for each of the 7.7 billion people on the planet.
What’s more, the group says this figure
is only going to increase.
The World Bank believes the speed
and scale of this debt wave
is something we should all be worried about.
So much so, the group has urged governments
around the world to make it a primary concern.
But let's take it a step back.
Put simply, debt is created when one party
borrows from another.
It allows individuals to buy something they
wouldn’t normally be able to afford.
That has its benefits.
For example, you might take on debt when you
get a loan to buy a car or mortgage on a house.
This allows you to pay back the cost of those
investments over time instead of all at once.
The cost of this service is the interest rate.
At present, interest rates around the world
have fallen to historically low levels.
This has made it cheap to borrow from banks,
meaning businesses can make large investments
and homeowners don’t need to spend as much
on their monthly mortgage payments.
There are drawbacks to a low-rate environment though.
Individuals aren't likely to see much of a
return on their savings, and both people and
businesses could load up on too much cheap
debt, something we’re seeing now.
Governments take on debt too, which they can
use to stimulate the economy by funding infrastructure
projects, social programs and more.
How much a country’s government owes is
known as sovereign debt.
Sovereign debt is very different to how we
might think about debt as an individual.
But, one thing they both have in common
is that problems tend to arise
when that borrowing becomes excessive.
Loans to countries with developed economies,
like Canada, Denmark or Singapore, are generally
seen as safe investments.
That’s because even if governments spend
beyond their means, lawmakers can raise taxes
or print more money to ensure they
pay back what they owe.
But loans to governments in emerging markets
are generally seen as much riskier, which
is why these countries will sometimes issue
debt in a foreign, more stable, currency.
Although this allows them to attract more
investors from abroad looking for bigger returns,
an economic slump, weak home currency or a
high debt burden can make it difficult for
the government to pay them back.
Ultimately, the most important risk when it
comes to national borrowing is
that a country may fall behind on its debt
obligations and default.
This isn’t common but it has happened.
Take Lebanon in 2020, Argentina in 2001
and Russia in 1998.
Over the last 50 years, there have been four
waves of debt accumulation.
We are currently in the midst of the fourth wave.
So, what can we learn from the first three?
Well for one, none of them had a happy ending.
Let’s start with the first wave.
In the 1970s, many Latin American countries
began to borrow extensive amounts of money
from U.S. commercial banks and other creditors
to support their development.
It didn’t seem like a problem at the time.
Interest rates were low, and Latin American
economies were flourishing.
But in the background, the debt wave was rising.
At the end of 1970, the region’s total outstanding
debt from all sources added up to $29 billion.
By the end of 1978, that number had shot up
to $159 billion.
Four years later, it had more than doubled
to $327 billion.
In the 80s, major economies began
hiking up their interest rates as they battled inflation.
Oil prices were sliding, and the world economy
was entering a recession.
In 1982, the starting gun of the Latin American debt crisis
was effectively fired, when Mexico announced
it would not be able to service its debts.
This move quickly sparked a meltdown
across the region, with the fallout spreading to
dozens of emerging economies worldwide.
Many countries in Latin America were forced to devalue
their currencies to keep exporting industries competitive
in the face of a sharp economic downturn.
Between 1981 and 1983,
Argentina weakened its currency against the U.S. dollar
by 40%, Mexico by 33% and Brazil by 20%.
Ultimately, 27 countries had to restructure their debts.
Sixteen of them were in Latin America.
The second wave ran from 1990
through to the early 2000s.
It was unlike the first in that
debt accumulation in the private sector
played a much more prominent role.
In the late 80s and early 90s, many advanced
economies deregulated their financial markets.
The policy changes led to many banks consolidating,
and these bigger banks operations became
increasingly global.
This helped prompt a massive surge of capital
into emerging markets, with falling interest
rates and a slowdown in advanced economies
also fueling the surge.
Developing economies began to rack up a lot of debt,
most notably Indonesia, South Korea,
Malaysia, the Philippines and Thailand.
Yet this growing wave of debt went largely
unnoticed.
You see, debt was growing rapidly, but so was GDP,
meaning the ratio between the two stayed consistent.
And most of the debt was hidden in the private sector.
A currency crisis in Mexico in 1994
thrust international investors back into panic-mode,
with the country’s default a decade earlier
still fresh in people’s minds.
Yet, while a $50 billion bailout from the U.S.
and the IMF meant Mexico was narrowly
able to avoid a default this time around,
it wasn't enough to stop panic spreading to
other countries.
It led to an abrupt stop and reversal
of capital flows in 1997.
By this point, Indonesia, South Korea, Malaysia,
the Philippines and Thailand had developed
a dependence on borrowing.
Coupled with several policy failings, this helped usher in
a crisis in East Asia's financial sector
and, ultimately, another global downturn.
While those impacted by the Asian financial crisis
recovered, international borrowing carried on
at a brisk pace.
Enter the third global debt wave,
which lasted from 2002-2009.
At the end of the previous century, the United States
removed barriers between commercial and investment banks,
while the European Union encouraged cross-border connections
between lenders.
This paved the way for the formation of
so-called ‘mega-banks.’
These banks led the way in a sharp increase
in private sector borrowing, particularly
in Europe and Central Asia.
Defaults in the U.S. sub-prime mortgage system
piled more and more pressure on the country’s
financial system, pushing it to the brink of collapse
in the second half of 2007 and 2008.
The shockwaves reverberated across the world,
with one economy after another falling into
a deep, albeit short-lived, recession.
In the U.S., the 2009 recession was so severe
that output from the world’s largest economy
sank to its lowest level since the Great Depression.
The World Bank says we are currently in the midst
of the fourth wave of global debt.
And to avoid history repeating itself yet again,
governments must make debt management
and transparency a top priority.
This wave of global debt is thought to share many
of the same characteristics as the previous three,
including prolonged periods of low
interest rates
and changing financial landscapes
which encourage more borrowing.
But the World Bank has called the current
wave
“the largest, fastest and most broad-based" of them all.
It involves a concurrent buildup of both public
and private debt, involves new types of creditors
and is much more global.
However, as the coronavirus pandemic
threatens to sink the world economy,
the moment for stemming the tide may have passed.
