Since the world’s public debt tripled in the mid-1970s, and many nations are currently experiencing financial difficulties, there is an increasing need to lower it and completely alter how we manage it.
The frequency with which the topic is brought up at high-level conferences is one indicator of how concerned international policymakers are about the extraordinary rise in global debt. It also comes up almost every week. In April 2024, International Monetary Fund (IMF) Managing Director Kristalina Georgieva told the Atlantic Council that she was concerned the current decade would be regarded as “the turbulent 20s.”
Across the world, the primary topic of discussion is debt, which is undoubtedly rising every day. The figures provide cause for concern. Gross borrowing for the 38 member countries that make up the so-called OECD region increased by precisely $2 trillion in 2023, from $12.1 trillion to $14.1 trillion. It will worsen: the OECD projects an additional $1.7 trillion increase in 2024. Even while the United States was the main offender, borrowing almost two-thirds of the $14.1 trillion in 2023, it is evident that this puts pressure on the global debt markets, whose ability to issue debt is limited.
Currently, there is a significant amount of debt in the markets. It is expected that the total borrowings, known as “outstanding marketable debt,” for 38 governments will reach $56 trillion by 2024. If that figure is striking, consider that it has increased by $16 trillion in just the last five years. This will mark a record level of debt.
The average debt-to-GDP ratio is likewise abnormal, which is possibly much more worrisome. From 73% in pre-COVID to roughly 83% in 2023, it has increased in real pre-inflation terms. And by the end of 2024, it will undoubtedly have increased. Meanwhile, interest rates are getting close to 3% of GDP, making new borrowing more expensive.
Pouring in more trillions
The performance of emerging markets is suffering. In 2023 alone, around $1 trillion more in sovereign bonds were issued in the so-called EMDEs (emerging market and developing economy) countries, bringing the total to $3.9 trillion.
China has a strong and quickly expanding appetite for this type of debt, even though it is hardly an EMDE. It now accounts for 37% of emerging nations’ bonds, up from 15% in 2021. Many issuers, both inside and outside of China, are alarmed by that figure.
It should come as no surprise that EMDEs borrow more against less because their economies are not expanding quickly enough, their credit ratings are declining, and the cost of debt is rising in tandem. According to the OECD, there were at least 24 downgrades and six upgrades in the group of low-income and lower-middle-income countries, which includes about 130 countries with an average per capita GDP of $12,300.
The unfavourable outcome is that the amount of outstanding governmental debt has increased to previously unheard-of proportions. Even though longer payback periods and inflation appear to improve these ratios, the debt still requires repayment. For many countries, it represents an imminent threat.
The makeup of the debt is just as important as its amount. The United States, the largest economy in the world, could have to refinance at least a third of its public debt by 2024, according to the OECD’s annual analysis of global debt. That is a minor issue of $11.3 trillion. The US Treasury will undoubtedly be in charge of the effort, but as the economic advocacy group Peter G. Peterson Foundation notes, it amounts to around $103,000 for each and every American.
According to the foundation, the cost of an ageing population, underfunded services, and other long-term contributing factors are some of the reasons why America’s debt load has been increasing for years: “a mismatch between spending and revenues.” The United States can at least bear its debt.
The OECD observes that “decisions on debt composition become even more intricate in emerging markets.” The Paris-based organisation characterises this as “exposure to fluctuations in global risk sentiment in an increasingly shock-prone world,” which is the reason they must deal with rising volatility.
IMF Deputy Managing Director Gita Gopinath is another policymaker who has often expressed her concerns. At a Washington conference titled Fiscal Policy in an Era of High Debt in late 2023, Gopinath presented concerning statistics regarding the long-term and rapidly rising levels of government debt. Global public debt has tripled since the mid-1970s and accounts 92% of GDP in 2022. Therefore, debt levels had been increasing for a while.
“Rising deficits and debts in countries such as the US have serious ramifications for emerging and developing economies, which are hit by rising rates and weaker currencies,” Gita Gopinath said, in sobering economic terms, presenting a grim picture, particularly for economically weaker nations. Additionally, many economies are already experiencing debt hardship, especially low-income nations.
Fractured fiscal rules
The old, more convenient regulations have been broken for several reasons, which is one of the numerous challenges involved with lowering global debt. One is the global financial crisis (GFC) of 2008, which overnight resulted in previously unheard-of amounts of quantitative easing, whereby central banks printed money and lent it to the financial sector at extremely low interest rates to support them.
Another issue is that, despite having their own fiscal policies, most countries are finding it increasingly challenging to adhere to them and are resorting to debt issuance to sustain economic activity. The OECD laments the “frequent deviations from the rules.” Since the GFC, few have managed to control their debt.
More discipline, supported by a form of fiscal police, is the OECD’s suggested remedy.
The OECD suggests, “We need rules anchored on spending targets that respond to shocks and have clear mechanisms to correct for non-compliance.”
Independent fiscal councils can also strengthen checks and balances.
Others, meanwhile, believe that a new form of economics is required. Atif Mian, a professor of economics, public policy, and finance at Princeton University, cautions that relying on credit to increase demand endangers the global economy and that the fundamental imbalances must be fixed.
However, until then, we have what he refers to as “a massive debt supercycle that threatens the global economy.” He continues by advocating for a “long-term balance between what people earn and what they spend” in an article published in the esteemed Finance & Development journal. One of the 21st century’s most urgent concerns is to break that loop.
Nevertheless, habits must shift before that may occur. The US and other mostly prosperous countries have made government (or sovereign) borrowing all but mandatory. Additionally, citizens who expected ongoing generosity from a country that could barely afford it criticised governments like Britain for using “austerity economics” when they attempted to lower their debt in the wake of the Great Financial Crisis. When the Macron administration tries to follow other countries and gradually raise the pension payout age, France is running into the same issues—riotous protests, in fact—which are slowly destroying the entire economy.
Accumulation of debt
Debt binges have been increasing for more than fifty years, beginning when the effects of the Great Depression started to subside. For instance, the United States’ overall debt more than doubled to 300% of GDP after hovering at 140% of GDP between 1960 and 1980. The American example has also served as a lesson to the rest of the globe.
According to Professor Mian, “Debt’s unrelenting upward trajectory could not be stopped, not even by the Great Recession of 2008 (the outcome of the GFC), which was largely caused by excessive borrowing.”
It would be incorrect to assume that 2008 was just the result of a few regrettable policy errors. Deep structural imbalances in the economy were the cause of the debt accumulation that precipitated the 2008 crisis. Both those inequalities and the risks they pose continue to exist.
However, what is the source of this hazardous imbalance and excessive debt? Most scholars agree that, ironically, the surplus savings of wealthy individuals and nations are a major underlying cause of economic issues. It is undeniable that the wealthy are growing increasingly richer, a trend that has persisted throughout history.
For nearly 40 years, the wealthiest 1% of people have been accumulating wealth at an accelerating rate, with many benefiting significantly from the digital boom. Thus, some nations have become richer than others, most notably China, whose growing wealth is invested far more in local banks and other savings institutions than in affluent Western countries. They each assert a disproportionately larger amount of the world’s revenue, which leads to financial surpluses that feed the “global debt supercycle.”
Regrettably, due to the banking sector’s failure to meet its objectives, a significant portion of this debt tsunami is being misdirected. A healthy financial sector would direct financial surpluses toward productive investments, like constructing and maintaining infrastructure and developing technology. Since investment returns would cover any debt resulting from such productive lending, it would be organically sustainable.
Mian continues, “The debt supercycle’s inability to fund profitable investment is regrettably one of its main characteristics. Real investment as a percentage of GDP has stagnated or even decreased during the past forty years, despite the fact that total debt as a percentage of GDP has more than doubled. The worrying conclusion is that we are wasting around half of the trillions of dollars in new debt issued in the last two years. Rather than funding investments that might contribute to wealth creation, it has instead been used to finance governments’ and consumers’ wasteful spending.”
Naturally, only falling interest rates fuel this cycle. Long-term memory holders will recall that the US 10-year real interest rate was approximately 7% in the early 1980s. It has recently fallen as low as below zero. Ordinary people are encouraged to spend rather than save as high rates enter the consumer finance system.
Handling crises
Debt-related catastrophes have occurred behind the scenes, virtually invisible to the public.
Central banks, which are responsible for maintaining financial stability, have had to control disruptions in the quickly expanding non-bank financial sector that could have had disastrous repercussions if they had spread more broadly. Only skilful and mostly anonymous crisis management prevented the worst.
In a recent lecture, Nick Butt, head of the Bank of England’s future balance sheet branch, says that “these non-bank institutions have grown in significance across a range of markets, including those that households, businesses, and governments use to borrow, save, or access financial services.”
About half of all UK financial assets, including corporate loans, have been acquired by non-bank institutions in the last 20 years, essentially from a standing start. Similar events have occurred in other European nations, posing yet another risk to the stability of the financial system.
Why? The reason for this is that non-banks often utilise the gilt repo market and maintain substantial holdings of gilts, also known as sovereign bonds, both domestically in Britain and internationally. The Bank of England buys and sells gilt-edged securities here, albeit few outside of the financial community are aware of how it operates.
Established in 1996, this massive market witnesses billions of transactions daily to maintain the liquidity of the banking system. As other central banks have noted, Butt asserts that the impact of the rise of non-banks is far from theoretical. They have created new weaknesses and sources of liquidity risk that have an all too real potential to cause financial instability and have an effect on the broader economy.
Some may argue that the current situation is more actual than prospective. During the COVID lockdowns, the UK government’s bond markets experienced a sharp decline in March 2020 due to a widespread rush for short-dated, cash-like securities. As banks of all kinds tried to fulfil their own liquidity commitments, there was a rush for cash throughout the financial industry. To support the central bank, the major dealer banks contributed almost £50 billion through the gilt market, but it was insufficient, illustrating the anxiety that permeates a heavily indebted economy.
The money markets managed to survive the crisis, despite the pressure. Two years later, Britain experienced another crisis immediately following the abrupt “go-for-growth” economic policy of the short-lived prime minister Liz Truss. This time, the long-dated gilt market was particularly affected, revealing what Butt referred to as “vulnerabilities in liability-driven investment funds” that threatened the nation’s financial stability.
Liquidity is crucial, particularly when non-banks receive the dreaded margin call, and their own creditors become alarmed. Central banks and international authorities are currently making significant efforts to close these gaps before they become too large.
Twenty years ago, the US Federal Reserve, the Bank of England, and other major institutions faced a simpler time, when they only had to worry about the large retail and investment banks, and the world’s debt levels were lower.
Responsible titans of banking
Positively, the majority of large, systemic banks around the world are safer now than they were before the Great Financial Crisis. They have greater capital, the funds that are first in line to absorb losses, and are better positioned to safeguard depositors as a result of the lending excesses made public by that crisis. Although there are regional variances, the majority of nations have implemented the rules created by the Bank for International Settlements, and international regulators are now considerably more at ease with the financial industry’s titans.
The United States, which is meant to be the land of regulation, experienced three bank failures in early 2023 alone: Silicon Valley Bank, Signature Bank, and First Republic. Meanwhile, the Swiss government needed to save the once-dominant Credit Suisse before it collapsed. The Swiss government planned for rival UBS to purchase the bank for $3.25 billion in June 2023 after a quagmire of poor regulation and incompetent management.
There are worries that a much-feared run on social media will increase the likelihood of bank failures. Prominent European bankers conducted a provocative study that suggests “the sudden withdrawal of bank deposits, celebrated by digital technology, contributed to the failures of these banks,” highlighting the rapid spread of misinformation.
According to the report, “social media and mobile banking apps were unheard of or barely existed” during the catastrophic bank runs that preceded the Great Financial Crisis.
What’s next?
The tightrope act calls for a gradual reduction in global debt and much more prudent investment, that is, in areas of the economy that will provide the proper growth. The majority of economists still support GDP, but they do it in a more sophisticated and nuanced manner that emphasises what is best for both people and the environment.
In summary, this represents significant progress. However, some argue that the usefulness of growth, particularly debt-funded growth, has outlived itself. The “degrowth lobby,” led by Greta Thunberg, contends that living standards are currently adequate and that modern capitalism has been mistaken in concentrating on GDP.
Academic circles do not widely accept the concept that “good growth” improves lives. But as the 10th edition of this insightful study, the IMF’s most recent World Happiness Report, demonstrates, economic growth isn’t everything. Indeed, some of the happiest countries are the poorest.
“It is evident that, although GDP per capita is a strong predictor of happiness, it is not the only element when we compare it with the report’s happiness rankings. Additional factors, including life expectancy, social support, independence, charity, and the lack of corruption, also contribute to the explanation of the disparities in happiness among nations,” the report stated.
In other words, the relationship between GDP and behaviour is significant. For this reason, despite having a GDP per capita of only $20,000, Costa Rica, which is well-known for its economic philosophy of la pura vida, which aims to consider everyone’s well-being, ranks a high 6.61 on the Happiness Index, while incredibly wealthy Singapore comes in slightly below.
Remarkably, poor countries like Guatemala (6.15 at $8,262), Nicaragua (6.26 at $5,842), and Kosovo (6.37 at $11,690) rank only below Singapore. Afghanistan, ranked lowest at 1.86, and Lebanon, ranked second at 2.39, are unlikely to trail the de-growth winners.
A strategic thinker, IMF Deputy Managing Director Gita Gopinath warns high-borrowing, wasteful countries.
“Debt-financed spending may nevertheless seem alluring in the current climate, where it is politically challenging to reduce expenditure or raise taxes. However, as borrowing costs climb sharply, that would be a serious miscalculation that would put debt on an unsustainable track. What governments can and cannot do needs to be reconsidered. The government cannot serve as the primary safety net for every unforeseen event. Additionally, revenues must match expenditures,” Gita Gopinath remarked.