Soaring government & private debt is worrying global financial authorities

They fear a rise in interest rates could cause global financial and economic downturn

THE world’s financial authorities are concerned about a massive surge in global government and private debt. They fear that a rise in interest rates could cause a financial and economic downturn.

The amounts are staggering. Both the Bank for International Settlements (BIS) and International Monetary Fund (IMF) have issued special reports highlighting the dangers.

From 2012 to the third quarter of 2017, government and non-financial private debt soared by $21.4 trillion to a record $173.5 trillion.

The average ratio of debt to gross domestic product (GDP) has reached 218 percent for the 43 nations that reported to the BIS.

Most economists and treasury officials tend to concentrate on levels of government debt. To reduce the levels, European nations, in particular, embarked on state austerity and high taxes. Inevitably stressed individuals and many businesses borrowed more. The debt problem was thus compounded.

The BIS figures show that private, non-financial debt (ie corporate and household debt) reached $112 trillion, or 65 percent of total global debt.

Early warning signs of global financial dislocation

The BIS, the central banks’ central bank, cautions that high levels of household and cross-border credit (for example, US dollar loans), have historically been early warning signs for potential financial crashes.

Household debt has jumped by 10.4 percent in five years to $44 trillion, as much as a quarter of total global debt. The BIS also stated that during 2017, US dollar credit rose by 8 percent to $11.4 trillion and euro credit by 10 percent to three trillion euros ($3.7 trillion). US dollar credit to emerging market economies jumped by 10 percent in 2017 at $3.7 trillion.

Total debt of Government and private non financial sector

A breakdown of Singapore’s debt, for example, illustrates the significance of private sector borrowing.

According to Trading Economics, Singapore’s government debt to GDP is 111 percent. Including private non-financial debt, the ratio rises to 284.6 percent, including a household ratio of 58.1 percent.

Australia’s household debt is as high as 121 percent of GDP or 51 percent of the total. China’s non-financial private debt is 211 percent of GDP or 82 percent of all its officially declared borrowings.

A monetary experiment that is haunting central bankers

Central banks, notably the US Federal Reserve, Bank of Japan, European Central Bank and Bank of England embarked on quantitative easing (QE) in the years since the 2008 financial crash. They slashed interest rates to zero or even negative rates to encourage borrowings to lift economies out of recession. A European debt crisis was averted, and several zombie banks managed to survive.

Following years of QE, economies have begun to recover but money has poured into financial assets, especially bonds, equities and property.

This is problematic. At minimal interest rates, high borrowing levels can be maintained. But if rates rise,  many borrowers will find it difficult to finance mortgages, credit cards and other debt.

Risks to financial stability–IMF and BIS officials fearful

In a recent speech, Tobias Adrian, director of the IMF’s Monetary and Capital Market, said that short-term risks to global financial stability have increased over the past six months. Stock market volatility and worries about trade protectionism have raised stress levels.

“Looking ahead, the odds of a downturn remain elevated, and there’s even a small chance of a global economic contraction over the medium term,” he said.

The main concerns are stretched equity and bond valuations, a weakening of corporate credit quality and vulnerabilities in emerging markets and low-income countries. Other worries are bank funding mismatches and synchronised house price increases around the world.

“As policy tightens in the US and elsewhere, the possibility of a widespread decline in house prices may pose risks to financial stability,” Mr Adrian said. “We found that house-price synchronisation tends to increase sharply in the run-up to a crisis.”

China’s banks and its shadow banking system are also vulnerable.

“China continues to face a delicate balancing act between protecting near-term economic growth and ensuring the medium-term stability of its financial system,” Mr Adrian said.

Central bankers are boxed in. If they raise rates, economies are likely to slow. If they don’t inflation is likely to accelerate

Such is the global problem, that the Fed and other central banks have already indicated that their rate rises will be gentle. They have promised to monitor financial and economic developments closely.

Despite that, they can only partially control the market and historically, their reactions have been slow.

If inflation surprises and spikes, investors could sell government and corporate bonds causing yields, including mortgage payments, to rise. Central banks would then have to pump money into the system to counter financial disruption.

© copyright Neil Behrmann

 Neil Behrmann is London correspondent of The Business Times Singapore. Jack of Diamonds his thriller on global diamond mining and smuggling, has just been published. It is the sequel to the thriller, Trader Jack, The Story of Jack Miner

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