Opinion: High debts and stagflation will bring the mother of all financial crises

Opinion: High debts and stagflation will bring the mother of all financial crises

NEW YORK (Project Syndicate) – The global economy is heading for an unprecedented confluence of economic, financial and debt crises, following the explosion of deficits, borrowing and debt over the past few decades.

In the private sector, the mountain of debt includes that of households (such as mortgages, credit cards, car loans, student loans, personal loans), businesses and corporations (bank loans, bond debt and private debt) and the financial sector (liabilities of banking and non-banking institutions).

In the public sector, it includes central, provincial and local government bonds and other formal liabilities, as well as implicit debts such as the unfunded liabilities of pay-as-you-go pension schemes and health care systems – which will continue all grow as societies age.

Dizzying debts

Just looking at explicit debts, the numbers are staggering. Globally, total private and public sector debt as a percentage of gross domestic product has risen from 200% in 1999 to 350% in 2021. The ratio is now 420% in advanced economies and 330% in China .

In the United States, it is 420%, which is higher than during the Great Depression and after World War II.

Of course, debt can stimulate economic activity if borrowers invest in new capital (machinery, housing, public infrastructure) that earns returns above the cost of borrowing. But much of the borrowing is simply to fund consumer spending that exceeds one’s income on a persistent basis – and that’s a recipe for bankruptcy.

Moreover, “capital” investments can also be risky, whether the borrower is a household buying a house at an artificially inflated price, a company looking to grow too quickly regardless of returns, or a government spending money. money for “white elephants”. (extravagant but unnecessary infrastructure projects).


This over-indebtedness has been going on for decades, for various reasons. The democratization of finance has enabled households short on income to finance their consumption through debt. Centre-right governments have consistently cut taxes without cutting spending, while centre-left governments have spent lavishly on social programs that are not fully funded by high enough taxes.

And fiscal policies that favor debt over equity, encouraged by ultra-loose monetary and credit policies by central banks, have fueled a surge in private and public sector borrowing.

Years of quantitative easing (QE) and credit easing have kept borrowing costs near zero TMUBMUSD10Y,
and in some cases even negative (as in Europe and Japan until recently). In 2020, government debt with negative yields in dollar equivalent was $17 trillion, and in some Nordic countries even mortgages had negative nominal interest rates.

Insolvent Zombies

The explosion of unsustainable debt ratios meant that many borrowers – households, businesses, banks, shadow banks, governments and even entire countries – were insolvent “zombies” supported by low interest rates (which kept their manageable debt servicing costs).

During the 2008 global financial crisis and the COVID-19 crisis, many insolvent agents who would have gone bankrupt were rescued by zero or negative interest rate policies, QE and outright fiscal bailouts.

But now inflation – fueled by the same ultra-loose fiscal, monetary and credit policies – has ended that financial dawn of the dead. With central banks forced to raise interest rates FF00,

in an effort to restore price stability, the zombies are experiencing a sharp increase in their debt service charges.

For many, this represents a triple whammy, as inflation also erodes real household income and reduces the value of household assets, such as homes and SPX shares,
The same is true for fragile and over-indebted businesses, financial institutions and governments: they face simultaneously sharply rising borrowing costs, falling revenues and revenues and falling asset values. .

The worst of both worlds

Worse, these developments coincide with the return of stagflation (high inflation accompanied by weak growth). The last time advanced economies experienced such conditions was in the 1970s. But at least then, debt ratios were very low. Today we face the worst aspects of the 1970s (stagflationary shocks) alongside the worst aspects of the global financial crisis. And this time, we can’t just lower interest rates to stimulate demand.

After all, the global economy is being battered by persistent short- and medium-term negative supply shocks that reduce growth and increase prices and production costs.

These include the disruptions of the pandemic in the supply of labor and goods; the impact of Russia’s war in Ukraine on commodity prices; China’s increasingly disastrous zero-COVID policy; and a dozen other medium-term shocks – from climate change to geopolitical developments – that will create additional stagflationary pressures.

Unlike the 2008 financial crisis and the early months of COVID-19, simply bailing out private and public agents with loose macroeconomic policies would pour more gasoline on the inflationary fire. This means there will be a hard landing – a deep and prolonged recession – in addition to a severe financial crisis. As asset bubbles burst, debt service ratios rise, and inflation-adjusted incomes fall in households, businesses, and governments, the economic crisis and financial crash will feed one another. the other.

To be sure, advanced economies that borrow in their own currency can take advantage of an unexpected surge in inflation to reduce the real value of some nominal long-term fixed-rate debt. With governments unwilling to raise taxes or cut spending to reduce their deficits, central bank monetization of deficits will again be seen as the path of least resistance.

But you can’t fool everyone all the time. Once the inflation genie comes out of the bottle – which will happen when central banks give up the fight in the face of the impending economic and financial crash – nominal and real borrowing costs will rise. The mother of all stagflationary debt crises can be postponed, not avoided.

Nouriel Roubini, professor emeritus of economics at New York University’s Stern School of Business, is the author of “MegaThreats: Ten Dangerous Trends That Imperil Our Future, and How to Survive Them” (Little, Brown and Company , 2022).

This comment was posted with permission from Project Syndicate — The Unavoidable Crash

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