By Nouriel Roubini
December 15, 2022:
Information Clearing House
-- The world economy is
lurching towards an unprecedented confluence of
economic, financial, and debt crises, following
the explosion of deficits, borrowing, and
leverage in recent decades.
In the private sector, the mountain of debt
includes that of households – such as mortgages,
credit cards, auto loans, student loans,
personal loans; businesses and corporations –
bank loans, bond debt, and private debt; and the
financial sector – liabilities of bank and
non-bank institutions. In the public sector, it
includes central, provincial, and local
government bonds and other formal liabilities,
as well as implicit debts such as unfunded
liabilities from pay-as-you-go pension schemes
and healthcare systems, all of which will
continue to grow as societies age.
Just looking at explicit debts, the figures
are staggering. Globally, total private- and
public-sector debt as a share of GDP rose from
200 per cent in 1999 to 350 per cent in 2021.
The ratio is now 420 per cent across advanced
economies, and 330 per cent in China. In the
United States, it is 420 per cent, which is
higher than during the Great Depression and
after World War II.
Of course, debt can boost economic activity
if borrowers invest in new capital – machinery,
homes, public infrastructure – that yields
returns higher than the cost of borrowing. But
much borrowing goes simply to finance
consumption spending above one’s income on a
persistent basis – and that is a recipe for
bankruptcy. Moreover, investments in ‘capital’
can also be risky, whether the borrower is a
household buying a home at an artificially
inflated price, a corporation seeking to expand
too quickly regardless of returns, or a
government that is spending the money on ‘white
elephants’, that is, extravagant but useless
infrastructure projects.
OVER-BORROWING
Such over-borrowing has been going on for
decades, for various reasons. The
democratisation of finance has allowed
income-strapped households to finance
consumption with debt. Centre-right governments
have persistently cut taxes without also cutting
spending, while centre-left governments have
spent generously on social programmes that
aren’t fully funded with sufficient higher
taxes. And tax policies that favour debt over
equity, abetted by central banks’ ultra-loose
monetary and credit policies, have fuelled a
spike in borrowing in both the private and
public sectors.
Years of quantitative easing and credit
easing kept borrowing costs near zero, and in
some cases even negative – as in Europe and
Japan, until recently. By 2020,
negative-yielding dollar-equivalent public debt
was US$17 trillion, and in some Nordic
countries, even mortgages had negative nominal
interest rates.
The explosion of unsustainable debt ratios
implied that many borrowers – households,
corporations, banks, shadow banks, governments,
and even entire countries – were insolvent
‘zombies’ that were being propped up by low
interest rates, which kept their debt-servicing
costs manageable. During both the 2008 global
financial crisis and the COVID-19 crisis, many
insolvent agents that would have gone bankrupt
were rescued by zero or negative interest rate
policies, quantitative easing and outright
fiscal bailouts.
But now, inflation – fed by the same
ultra-loose fiscal, monetary, and credit
policies – has ended this financial Dawn of
the Dead. With central banks forced to
increase interest rates in an effort to restore
price stability, zombies are experiencing sharp
increases in their debt-servicing costs. For
many, this represents a triple whammy, because
inflation is also eroding real household income
and reducing the value of household assets, such
as homes and stocks. The same goes for fragile
and over-leveraged corporations, financial
institutions and governments: they face sharply
rising borrowing costs, falling incomes and
revenues, and declining asset values all at the
same time.
Worse, these developments are coinciding with
the return of stagflation – high inflation
alongside weak growth. The last time advanced
economies experienced such conditions was in the
1970s. But at least back then, debt ratios were
very low. Today, we are facing the worst aspects
of the 1970s stagflationary shocks alongside the
worst aspects of the global financial crisis.
And this time, we cannot simply cut interest
rates to stimulate demand.
After all, the global economy is being
battered by persistent short- and medium-term
negative supply shocks that are reducing growth
and increasing prices and production costs.
These include the pandemic’s disruptions to the
supply of labour 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 in the 2008 financial crisis and the
early months of COVID-19, simply bailing out
private and public agents with loose macro
policies would pour more gasolene on the
inflationary fire. That means there will be a
hard landing – a deep, protracted recession – on
top of a severe financial crisis. As asset
bubbles burst, debt-servicing ratios spike, and
inflation-adjusted incomes fall across
households, corporations, and governments, the
economic crisis and the financial crash will
feed on each other.
LEAST RESISTANCE
To be sure, advanced economies that borrow in
their own currency can use a bout of unexpected
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
deficit monetisation will once again be seen as
the path of least resistance.
But you cannot fool all of the people all of
the time. Once the inflation genie gets out of
the bottle – which is what will happen when
central banks abandon the fight in the face of
the looming economic and financial crash –
nominal and real borrowing costs will surge.
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.© Project Syndicate 2022www.project-syndicate.org
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in this article are
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