The IMF’s recent warning should be taken very seriouslyby / April 23, 2018 / Leave a comment
Global public and private debt, according to the International Monetary Fund, reached $164 trillion in 2016, the equivalent of 225 per cent of global GDP. This is almost $50 trillion more than in 2007. In advanced economies, the level of debt as a share of GDP was higher in 2016 than at any time since World War Two, while in emerging and middle income countries the debt share was at its highest since the Asian crisis in 1997-98. By the end of this year, the world will be still deeper in debt. Is this the next economic crisis?
The IMF warning isn’t new, and Cassandras have warned since the financial crisis that debt would be the ruin of the global economy. Some of the biggest global debtors, such as the United States, China and Japan have been living with large debt for a long time without risk of imminent crisis, and so the notion that rising global debt is going to tip the world into another systemic financial crisis is misguided. That said, it would be wrong to be complacent. Some countries, especially in the emerging world, could be at significant risk from taking on excessive debt, and we should all be aware that high debt makes governments, companies and households especially vulnerable in the event that other things should go wrong, which well they might.
Remember what happened in the 2000s. For the best part of a decade, levels of private sector debt rose relentlessly, especially debt owed by households, mostly mortgages. Leverage in the financial sector, that is borrowing to finance loans and investments rose to absurdly high levels, especially in relation to the limited capital of financial institutions. No one worried while asset prices, including housing, rose, liquidity was plentiful, and interest rate costs remained low. Once these benign conditions changed, though, as they were bound to, the proverbial pack of cards of debt collapsed with devastating effect.
Fast forward to 2018, and here we are again, with four important differences.
First, while debt is now significantly higher, the tighter regulatory environment has lowered the riskiness of banks to a meaningful, if not totally satisfactory, extent. While a large debt burden is liable to make any economic downturn more painful for governments, banks and individuals, there is less risk of a repeat systemic financial crisis. Good news—but that’s where it stops.
The second point is that while most developed economies have stabilised or lowered their total debt burdens, the US is going out on a limb thanks to recently enacted tax cuts. According to the bipartisan Congressional Budget Office and the IMF, US fiscal deficits of about 5 per cent of GDP are on the way back, pushing Federal debt outstanding up from just over 100 to about 117 per cent of GDP by 2023. This is worrisome for the US economy’s resilience and dynamism, and may accentuate the risk of rising-interest rates in the next year or so.
“Global debt reached $164 trillion in 2016, the equivalent of 225 per cent of global GDP”
Third, while the US, Japan and other developed economies account for the bulk of global debt, the increase since 2007 is almost wholly due to emerging and middle income countries, notably China which accounts for nearly 45 per cent of the increase. By my reckoning, China’s debt climbed to 300 per cent of GDP in 2017, even though the pace of the rise has slackened since 2017 thanks to the government’s financial clampdown on excessive risk-taking. About a fifth of China’s debt is owed by the government, including both Beijing and local and provincial governments. But the IMF’s so-called “augmented debt” estimate, which comprises a broader definition of public sector debt and liabilities, is about 100 per cent of GDP, and if included, would push total debt up by an additional 40 per cent or so of GDP.
China matters to global financial and economic stability in bigger ways than a decade ago. It is going to be important if the government is prepared to bite its bottom lip and allow deleveraging to continue, slowing down the Chinese economy, perhaps materially, or if political sensitivities lead it to stoke up credit and infrastructure spending, with more troublesome consequences down the road.
Fourth, unlike a decade ago, the steadily rising burden of pension and healthcare spending is starting to become a pressing real time issue. The projected increase over the next 30 years in G20 countries is predicted at about 3-4 per cent of GDP, but this gives an inadequate sense of what is actually unfolding. The net present value of pension and healthcare spending programmes out to 2050 is basically what it would cost to honour existing laws and promises expressed in today’s money. The IMF’s updated data, in last week’s Fiscal Monitor, suggest that for the G20 countries, the actual bill amounts to 107 per cent of GDP. Among the most badly affected nations are South Korea (159 per cent), the US (153 per cent), China (101 per cent), Germany (88 per cent) and the UK (73 per cent).
While governments do not have to foot these bills today, of course, the sheer scale of future age-related spending is a reminder that governments have much less flexibility to adjust spending and tax policies than they once had. They will be hemmed in by age related spending, including during future economic downturns, until or unless they engage in a proper public debate about how to finance and fund ageing societies.
For reasons mentioned, the IMF’s global debt warning merits serious attention. The global economy may be on the verge of a damaging trade war between the US and China, which may spill over to other countries and impact on the volume of world trade. The flow of cross border investment is already coming under much greater political and regulatory scrutiny on both sides. The negative consequences would affect everyone, but especially trade-dependent emerging economies. The US Federal Reserve may, as I have pointed out before, raise interest rates another two-three times this year and perhaps three-four times in 2019. This would raise financing and funding costs for borrowers in US dollars, again with a significant impact especially on emerging countries that have borrowed so much more in recent years. Global liquidity could diminish as financial conditions tighten, trade and investment slow down, and Chinese growth continues to slow.
The burden of global debt can only be lowered over time as money GDP, which is the denominator of the debt ratio, continues to rise. Yet more is probably needed, and that is why the IMF is arguing that in good economic times, countries need to build a social and political consensus around how to lower the burden of current and future debt. But time is short. By 2020, if not sooner, the first economic downturn since the financial crisis may be upon us. At that point, we will see more clearly how high debt has limited our fiscal flexibility.