We should worry about debt as well as inflation


This week, even more stunning economic data emerged. Take inflation. On Wednesday, it emerged that annual inflation in the United States had hit 9.1% in June, its highest level since 1981.

Unsurprisingly, this has given rise to increasingly strong expectations of future increases in interest rates. This, in turn, prompts bodies such as the IMF to drastically cut growth projections, in the United States and elsewhere.

But as investors and economists worry about the recession, there is another related question to ponder: how will high inflation and rising rates affect the growing mountain of global debt?

For most of the past decade, this debt issue has often been overlooked by experts, as a decades-long decline in rates and inflation has kept borrower servicing costs low or low. falling. But Wednesday’s figure underscores that the climate has changed. The debt data is just as impressive as the inflation.

A recent report by JPMorgan, which analyzes statistics from the Institute of International Finance, details the problem very clearly. He notes that total global debt was 352% of gross domestic product in the first quarter of this year, with private sector debt accounting for two-thirds of that amount and public sector debt one-third.

The good news is that this ratio has fallen slightly from the peak of 366% at the start of 2021, due to strong global growth. The bad news, however, is that the current ratio is still 28 percentage points above 2019 levels, before the Covid-19 lockdowns triggered frantic government and private sector borrowing.

Moreover, the pandemic-era rise was widespread and came after a sharp rise in debt during the 2008 global financial crisis – and the former was considerably larger than the latter. Thus, total global debt today, relative to GDP, is more than double its 2006 level – and triple the ratio in 2000 (when it was below 100%).

Yes, you read that right: leverage in the global economic system has more than tripled this century; and the only reason this went (mostly) unnoticed was falling interest rates.

What happens now if rates go up? Nobody knows. If you want to be optimistic, you could say that there is no need to panic since spiraling debt is a feature of an increasingly globally integrated world, not a bug. Just as 21st century consumers often use credit cards instead of cash to make purchases, making consumer debt higher than before, even if retail spending is unchanged, business activity today is fueled by increasingly complex credit flows.

Within the overall gross debt numbers, there are also credit flows that sometimes cancel each other out, and the rising value of liabilities is sometimes accompanied by a rise in the value of assets. So, while Japan has the highest debt-to-GDP ratio in the world, different government agencies have become indebted to each other.

And while China’s private sector debt is nearly three times GDP, the deep-pocketed government is implicitly backing some loans. Similarly, while the United States also has debt three times its GDP, this borrowing is partly offset by the rise in the value of private and public assets.

“The total increase in gross debt could exaggerate the increase in debt vulnerabilities,” notes a recent report by the Committee on the Global Financial System. He adds that any “analysis of distributions [of vulnerabilities] requires microdata, which are often not available from public sources”. The nature of the creditors, the value of the compensation assets and the maturity of the debt are important.

Still, even with these caveats, the trend clearly worries the CGFS — so much so that its report uses internal central bank data to try to model some of the private sector’s “vulnerabilities.” This produces an assortment of startling microdata. To cite an example: while 50% of the pandemic-era debt taken up by companies in Italy and Spain comes due within the next two years (making them vulnerable to rising rates), in Germany and in America, the ratio is only 25 percent.

Or, to quote another: the CGFS calculates that 17% of companies in industrialized economies are “zombies,” or entities that can only be kept alive through low rates; in 2006, this ratio was 10%. A third nugget: some 90% of German households expect house prices to continue to rise, up from 40% at the start of 2020 – a trend that could “amplify the current recovery in household credit”, according to the CGFS.

These details suggest that rising rates will create many mini debt shocks in the years to come. Indeed, these are already erupting: in the sovereign sector (say, with Sri Lanka); the Western corporate world (with Scandinavian Airlines or Revlon); and the emerging market corporate sphere (in cases like Evergrande in China)

But the truly intriguing question is the most important one: can a triple-leverage system ever truly deleverage, without suffering a full-fledged crisis (i.e. massive default)? After all, growth is unlikely to provide a way out. And while inflation is “a potential avenue for reducing debt to GDP,” as the JPMorgan report notes, it only works if inflation “is unanticipated and doesn’t drive up interest rates.” “. Therein lies the challenge for central bankers – and the huge philosophical question hanging over our 21st century global economic system.

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