Looming global debt crisis: reasons to worry about the elephant in the room

The mountain of global debt has grown to record size in the past decade but has gone largely unnoticed as governments keep spending and printing money
Global financial institutions are now sounding the alarm, but governments and central banks are in no mood to listen

Anthony Rowley

Published: 3:30am, 16 May, 2022

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“We live in dangerous times,” two senior International Monetary Fund economists wrote in a recent blog. Few would challenge that assessment as the world confronts the multiple threats of possible nuclear conflict, galloping inflation, rising interest rates, economic recession and the ongoing Covid-19 pandemic.

But it was a more specific danger to which the IMF officials were referring. It was a new global debt – and maybe financial system – crisis erupting in public and private sectors of the global economy and in both advanced and emerging economies, the latter initially.

Debt crises have a way of keeping their heads below the parapet until they attack, but once they do so it is often with great ferocity. As World Bank chief economist Carmen Reinhart put it, “Prior to crises, it’s often the things that you don’t see that ultimately get you.”

Debt mountains such as the one we have now are the elephants in the room. They are huge but often go unnoticed or unacknowledged. This one had reached US$303 trillion – some three times the size of global annual GDP – by the end of 2021, according to the Institute of International Finance.

It has been growing for a decade or more, so why is there “reason to worry” now, as a recent IMF report on global debt suggested? One reason is the growth of the sovereign bank nexus or “ doom loop”, whereby banks become holders of government debt to a point where their viability is at risk.

Has China’s debt changed in 2021 and how big is it now?

Banks’ holdings of sovereign debt have risen to record levels as governments have undertaken spending to cushion the impact of the pandemic. This is increasing “the odds that pressures on public-sector finances could threaten financial stability”, as the IMF has observed.

Governments around the world have spent aggressively to help households and employers weather the economic impact of successive waves of Covid-19. This means the burden of keeping economies afloat has been passed from businesses and households to governments and then on to banks.

Where does the buck stop? Modern Monetary Theory has come into vogue with many economists, though others deem it as implausible as the idea of a magic money tree. It has encouraged policymakers to believe they can go on issuing public debt ad infinitum.

The cost of money doesn’t seem to have occurred to those making such assumptions. At least some have argued that interest rates stabilised at a new and low “natural” or neutral level, from where they were unlikely to rise in the foreseeable future.

Why China, like Japan, needn’t worry about paying all that debt back

Enter Covid-19, the Ukraine war and all the supply chain disruptions these twin blights have brought. The notion that the global financial system has stabilised in a serendipitous new normal has evaporated like a will o’ the wisp, and crisis scenarios are back in fashion.

The sheer volume of warnings sounded during the recent spring meetings of the IMF and World Bank, its Bretton Woods sister institution, was obviously intended to tell policymakers the risk of a debt crisis was very real.

“As economies recover and inflation accelerates, governments should take account of the impact of fiscal and monetary policy tightening on the most financially stretched consumers and businesses when pacing the exit from extraordinary support policies,” the IMF urged.

But governments are preoccupied with inflation, especially in the United States and Europe. They are also focused on the knock-on impact of inflation on monetary policy, interest rates, appreciating currencies in advanced economies and resulting capital outflows from emerging economies.

They are in no mood to listen. This is especially the case with the US Federal Reserve, which by virtue of its official remit is obliged to pay more attention to US domestic economic and financial priorities than to the impact these have on the global economy.

A great irony is that when banks and other major financial institutions have been on the point of failure in the past, most recently during the 2008 global financial crisis, they turned to governments to bail them out and were duly deemed “ too big to fail”.

Where will they turn this time, when governments themselves are reliant on banks to fund their massive post-pandemic spending needs that will grow even larger in the wake of the Ukraine conflict and in the light of a probable global recession?

It is difficult to see where we go from here. Perhaps it will be into a corrective contraction to compensate for past excesses and for the artificial expansion of demand via excess money creation and asset inflation, or maybe into a great inflation that will erode away the debt mountain.

All this has implications that go beyond possible debt crises and bank or even systemic financial failures. It will have implications for the balance of strategic power, and it is noteworthy in this regard that China is wheeling out new fiscal stimulus just as the US closes the monetary tap.

Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs