According to a report by the Institute of International Finance, the global debt load is currently at approximately $244 trillion, which makes up 318% of global GDP. Furthermore, the debt pile has been growing over 12% since 2016.
Possible Credit Crunch
This massive growth of the global debt pile comes due to a decade of near-zero percent interest rates, encouraging governments, businesses, and consumers to accumulate debt at little cost. With all-time-high global debt levels, we are seeing central banks beginning to raise interest rates around the world.
With the cost of their debt rising, many debtors will be ill-equipped to service their debt and forced to default, which will cause lenders to call certain loans due to retain their liquidity. When speaking to reporters about this issue, IIF Executive Managing Director Hung Tran said that “Non-financial borrowers in the corporate sector, in the household sector, in the government sector having very high debt levels, will find it very costly and difficult to refinance and borrow more in order to sustain investment and consumption going forward. That is really causing growth to falter, so what I term headwinds to growth,”
Emerging Market Debt
When the subject of global debt is brought up, many are quick to stick the blame on the developed nations like the United States, China, and the United Kingdom. However, there’s a dangerous trend developing. Emerging market debt is actually growing faster than developed market debt in all categories except government debt.
A big concern for investors and economists is that the debt incurred during the ZIRP (zero interest rate policy) era post-crisis has been misallocated, that unprofitable companies have been allowed to lever up with few consequences.
This misallocation has been encouraged by the use of forward guidance by central banks. In other words, central banks will guarantee that short-term interest rates will remain close to zero for a coming period of time. As a result, investors have felt safe investing more capital into unprofitable companies that are growing due to cheap debt.
Further, the companies benefitting from these risky investments are encouraged to resort to tactics to fuel short-term growth, possibly sacrificing the long-term.
How Did We Get Here?
In the face of record-high global debt, many are asking, ‘how did we get here?’
As a response to the global financial crisis, the Federal Reserve acted swiftly and decisively in effort to stabilize the economy. They instituted a target interest rate to between 0% and 0.25%, a historically low rate for the United States. In order to achieve this, they developed a quantitative easing program.
The program’s goal was to get banks to lend money, and in order to do this, the Federal Reserve bought assets from the banks to give them the liquidity to start lending again. Further, the Federal Reserve bought US Treasury bills in the open market in order to drive down their yields, again encouraging banks to lend.
While this did work in the short-term, it has largely contributed to the massive level of debt accumulation we see in the United States and abroad.
The global economy is still growing at a steady clip, but with central banks around the world hiking interest rates, we may see some debt servicing issues on the horizon, especially with the acceleration of non-financial corporate debt, which rose to an all-time high of 92% of GDP in the third quarter of 2018.
Article By: Patrick Crawley