SINGAPORE: The world is in more debt now than before the global financial crisis.
Many would remember the previous decade for the economic jitters the global financial crisis in 2008 caused - sending markets crashing as well as financial firms and their staff packing.
The high debt burden then, at 208 per cent of GDP in June 2008, is said to be one of the factors underpinning the crisis.
The financial sector, in particular, had contributed to household and corporate debt by lending widely to the market, which led to a US housing bubble and a consequent subprime mortgage crisis. Banks also borrowed using opaque financial instruments and when they were hit by some shocks, slowed down their lending, leading to a liquidity crisis.
Following this, the European debt crisis hit several countries across Europe the following year.
WE ARE THERE AGAIN
A decade later, things have worsened.
According to the World Economic Forum’s (WEF) Global Risks Report 2019, the global debt burden now is significantly higher than before the crisis – at 225 per cent of GDP.
In the first half of this year, global debt had hit a record US$250 trillion, a report by the International Institute of Finance (IIF) recently showed.
The financial sector is still a major player in this accumulation of debt. According to the WEF report, in countries with a systemically significant financial sector, the debt burden is even higher at 250 per cent of GDP.
In 2008, this figure stood at 210 per cent.
HAVE WE LEARNT?
It is somewhat surprising that we are in this level of debt considering that in the early years of this decade we saw several advanced economies and European nations, like Greece and Spain, undertake austerity measures.
The Japan and US even had credit downgrades to penalise them for having high debt levels.
So, how is it then that by end of the 2010s we are in a worse position than ever before? Have we not learnt any lessons from the crisis and from the previous decade?
Before we start pointing fingers at the financial sector, each other and cry greed, let’s see what went wrong.
Actually, there hasn’t been much scope to right the wrongs that happened during, and as a result of, the crisis.
LOW INTEREST RATES
One of the main factors behind this high global debt are interest rates.
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Interest rates were already low before the crisis broke in 2008. In fact, it was the availability of this cheap credit that fuelled the housing bubble in the US.
When the crisis broke, governments around the world turned to monetary policy, fiscal stimulus and corporate bail-outs to contain the recession.
Central banks kept cutting the already low interest rates in a bid to first, rescue their economy and, then, boost it.
As a result, we now live in an era of even lower interest rates. In developed economies, interest rates are less than 2 per cent.
In some countries, we now have negative interest rates as governments are looking at ways to get people to spend to boost their economies and save less. Sweden was the first to do this post-crisis. Denmark and Switzerland too have interest-rate measures to boost spending and reduce savings. The UK is now also in negative rates territory.
PRIVATE BORROWING GREW
The low rates have allowed businesses to borrow cheaply, pushing debt up.
Which is why much of the shoulder-breaking debt burden we see now is caused by private borrowing.
Comparing against the crisis, the International Monetary Fund (IMF) explained that in advanced economies the corporate debt ratio has gradually increased since the beginning of this decade and is now at the same level as 2008 - the previous time it peaked.
The US and China are the biggest culprits of this private debt accumulation, according to the IMF. The US saw its corporate debt grow consistently since 2011 to hit record high levels at the end of 2018. China, on the other hand, has seen its corporate debt increase compared to other emerging markets.
THE END OF MONETARY POLICY
So why don’t central banks simply increase interest rates to avoid falling into a potentially risky situation? After all, if they make borrowing more expensive then private debt should fall.
It is not so simple. The low rates of interest have blunted governments’ abilities to stimulate economic growth. Since interest rates are near zero or, in some cases, negative, they cannot slash it any further to boost spending.
This has made monetary policy ineffective and perhaps even redundant. In the absence of monetary action, governments are left with fiscal stimulus to grow their economies.
That is why throughout this decade, as interest-rates remained low and could not do anymore to stimulate the economy, governments spent instead, pushing up public debt.
GOVERNMENTS HAD TO SPEND
The IIF estimates that by the end of the year, global government debt will top US$70 trillion in 2019, higher than the US$65.7 trillion in 2018.
The problem with relying mostly on fiscal policy is that governments have to balance what they spend in terms of revenue. But many of the advanced economies were dealing with record levels of unemployment in the aftermath of the crisis, so revenue sources such as income tax and indirect taxes were low.
This is why governments had to borrow to fund their stimulus spending over the decade. The IMF stated that the public debt ratios in 90 per cent of advanced economies are higher than before 2008.
It is no wonder that, according to the IMF, in 2018 half of the advanced economies put an end to this unsustainable spending to run fiscal surpluses whereas a third reduced their fiscal deficit or increased their fiscal surplus compared with the previous year.
NO ROOM TO GROW
As governments incurred consistent budgetary deficits (high spending and low revenue), it was unsustainable for them to borrow to finance their spending to stimulate the economy.
Which likely explains why the 2010 to 2019 decade is the longest economic recovery period ever seen.
The challenge for governments in the next decade though is more complex than ever.
On the one hand, they cannot lower interest rates to stimulate economic growth. But there is also a limit to how much fiscal stimulus governments can use to spur the economy as they have budget deficits and public debt limitations to worry about.
Raising interest rates to attract foreign capital into the economy is also difficult as it could further dampen economic growth by giving a boost to savings and reducing consumer spending.
But a high global debt situation in a low growth, low interest rates economy is also very risky. At least in 2008 when trouble hit, governments could slash interest rates and spend to save their economies.
What tools could government effectively use to fight the next fire?
Malminderjit Singh is editor at CNA Digital News, Commentary section.