The world is in debt — prepare for economic turmoil

opinion

by desmond ruckman

When it comes to national debt overhang, the four most dangerous words are: “This time it’s different.”

As Harvard University’s Kenneth Rogoff and Carmen Reinhart taught us in their authoritative book, This Time It’s Different: Eight Centuries of Financial Folly, excessive debt is almost impossible unless dealt with quickly. , the result is an economic crisis, a banking crisis, or a currency crisis.

How worried should we be about the world’s long-term economic outlook?

It is not just a single major country with burdensome debt.

All of the world’s major economies have serious debt problems caused by years of irresponsible budgetary policies and zero interest rates, which could make it more difficult to avoid domestic recession and fiscal re-straining. There is sex.

Let’s take the United States, the world’s largest economy, as an example.

Even though the country should be running a fiscal surplus during good economic cycles, it manages to run a deficit of about 6% of gross domestic product.

According to the nonpartisan Congressional Budget Office, under current policies, these deficits will continue as far as the eye can see.

As a result, interest payments on public debt will be higher than during World War II, given the size of the economy.

Since our government borrows in dollars, there is little chance of default, even if the debt reaches astronomical levels.

The Federal Reserve can always print money and pay it back.

However, there is a strong possibility that such money printing will lead to further increases in inflation and a dollar crisis.

Unfortunately, we not only have a public debt problem, we also have a commercial real estate debt problem.

Approximately $1.5 trillion in commercial real estate debt will mature over the next two years.

With post-COVID vacancy rates at record levels and interest rates much higher than in the days of easy money, consider how these debts can be rolled over without major debt restructuring. It’s difficult.

So it’s only a matter of time before we see a wave of local bank defaults that could shake up the financial system, like the failures of Silicon Valley Bank and First Republic Bank last year.

China, the world’s second-largest economy and until recently the main driver of economic growth, also has a major debt problem.

Over the past decade, China’s credit to the non-financial private sector has increased by about 100% of GDP, according to the Bank for International Settlements.

This is higher than the rate of debt growth seen during Japan’s Lost Economic Decade of the 1990s and before the US Great Recession of 2008-2009.

With the bursting of real estate and credit market bubbles, China could enter an economic lost decade.

Europe’s debt problems are mainly concentrated in the southern part of the euro area.

Public debt as a percentage of GDP in Italy and Spain is significantly higher than during the 2010 eurozone debt crisis.

Complicating matters, these countries are bound by the euro and cannot use their own exchange rate or interest rate policies to offset the negative impact on aggregate demand from budget belt tightening. That’s true.

A recurrence of the euro area debt crisis is inevitable.

As if this were not enough cause for concern, Japan, until recently the world’s third-largest economy, has public debt levels of more than 250% of GDP, about twice that of the United States.

This has not been a problem so far, as the Bank of Japan effectively funds the government by keeping long-term interest rates below 1%.

However, Japan’s public debt crisis could occur if rising inflation forces banks to abandon their experiments with yield control.

With so many large-scale debt problems around the world, it is difficult to avoid a day of global economic reckoning.

Global economic policymakers recognize that we are sleepwalking towards a global crisis and are mitigating such a day by taking steps to make debt more sustainable. There is a possibility that it can be done.

If not, we should prepare for domestic economic turmoil and renewed tensions in financial markets as economic problems abroad spill over into our country.

Desmond Luckman, a senior fellow at the American Enterprise Institute, was the deputy director of policy development and reviews at the International Monetary Fund and chief emerging market economics strategist at Salomon Smith Barney & Co..