Nov 20th 2019

Buckle up for turbulence: why a global debt crisis looks very hard to avoid

by Rodrigo Olivares-Caminal

 

Rodrigo Olivares-Caminal is Professor of Banking and Finance Law, Queen Mary University of London

 

Moody’s, one of the big three credit rating agencies, is not upbeat about the prospects for the world’s debt in 2020 – to put it mildly. If we were to try to capture the agency’s view of where we are heading on a palette of colours, we would be pointing at black – pitch black.

Moody’s rates the creditworthiness of 142 countries, which represent about US$62.2 trillion (£48 trillion) of debt. It sees a disruptive political environment both within various countries and at the international level.

This, it says, is aggravating the slow-motion stagnation of global GDP growth that has been a problem since the financial crisis of 2008-09. Together, these difficulties have the potential to worsen the effects of unresolved structural issues in different countries, such as fast-ageing populations, income inequality, poor competitiveness, low currency reserves and poor policies for managing sovereign debt. The net result could be sovereign debt defaults that could trigger new economic and financial shocks and lead to serious instability in the months ahead.

As a professor of banking and finance law, I broadly agree with this prognosis. So where are the most serious flashpoints, and what can politicians and civil servants do to minimise the risks?

Welcome to the cauldron

Unfortunately, the world is sitting on a sovereign debt timebomb that could be triggered at any time by the smallest event. This is confirmed by the IMF’s data, which identifies 32 countries as being at high risk of unsustainable debt. Their borrowings have more than tripled in just two years. We have to remember how serious the consequences can be when a country’s finances spiral out of control: take Venezuela, which is facing a humanitarian crisis with projected inflation of 10,000,000% by the end of this year.

Moody’s argues convincingly that the main drivers of the problems threatening to tip these high debt levels into crisis are twofold: the recent disruption to world trade and the weakening of global and national institutions. World trade in goods is heading for its worst year since 2009, mainly driven by the geopolitical tensions resulting from the trade war between the US and China, and to a lesser extent the Brexit uncertainty in Europe.

The US-China standoff has affected trade volumes between the two superpowers. It has also meant that countries which play an important role in the global supply chain, such as Belgium, the Czech Republic, Ireland, Malaysia, Singapore and Vietnam, will face a slowdown in their economic activity.

Trading insults. Samrit Foljan

Beyond this are indirect consequences that could kick off a crisis: confidence is reducing across the board, and short and medium-term growth is projected to slow down. This threatens to reduce foreign direct investment and capital flows into many countries – Moody’s argues this is already evident in the Asia-Pacific region.

The same thing looks likely to happen to those countries with large account deficits who are more reliant on overseas capital, such as Argentina, Lebanon, Mongolia, Pakistan, Sri Lanka, Tunisia, Turkey and to a lesser extent Indonesia. Capital flight will send their currencies plummeting and make their dollar-denominated debts even more unsustainable, raising the prospect of political strife and contagion.

The division bell

Nationalism and populism are ascendant across the world, undermining the effectiveness of domestic, regional and global policy now that the era of centrist political consensus has ended. As Moody’s notes, this lack of international cohesion has made it harder for institutions, such as the World Trade Organization and G20, to help coordinate policy responses to economic difficulties.

It doesn’t help that there is also a large amount of bilateral antagonism at present – not only US/China and UK/EU, but also Japan and Korea, China and Japan, North Korea and the US, India and Pakistan, Russia and Ukraine and the ever-present tensions in the Gulf.

In this climate, populist movements are turning the growing anger over rising income inequality to their advantage, as we have seen in the likes of Argentina, Ecuador, Mexico and particularly Chile. Other countries facing similar issues include Ethiopia, Iraq, Lebanon and Tunisia.

In response, governments are being forced to shift their policies. For example Argentina’s government had to reinstate price controls, which was one of its most criticised policies. Any quick populist fix may quiet discontent, but it doesn’t address structural challenges and only serves to highlight weak governments.

This is not just restricted to emerging markets: Moody’s also recently changed the outlook of the UK to negative, amid the uncertainty surrounding Brexit and the log-jammed parliament. Similarly in the US, the ongoing impeachment process against President Trump and political polarisation are distracting policymakers from more essential and pressing matters – not least the sluggish economy. A ratings downgrade cannot be ruled out entirely.

This should all serve as a wake-up call to other countries with longstanding unresolved structural challenges. Sri Lanka, for example, has large account deficits that cannot be reduced, while India’s credit outlook has also been downgraded to negative because its government’s economic policies have been ineffective at producing growth. Many countries, meanwhile, need to do more to address other challenges, such as robotisation and the emergence of AI, or simply reform fatigue.

Put this all together and it looks like a very toxic mix. Countries need to recognise their mutual interest in avoiding a full-blown debt crisis. They need to try to overcome their differences and embrace a cohesive approach towards development and tackling the debt problem.

It may even be too late. There are some parts of the world, such as Africa, where debt is already getting very close to a regional crisis. Latin America and the Caribbean are also at risk, although some countries are already restructuring their debts.

At any rate, the international community must do what it can before time runs out. For the future, there are two vital lessons: countries need to tackle their structural issues early, and borrowing must be used for investment and not simply to finance budget deficits. If the world can make genuine progress on these fronts, situations like this can hopefully be avoided in the future.

Rodrigo Olivares-Caminal, Professor of Banking and Finance Law, Queen Mary University of London

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Browse articles by author

More Current Affairs

Jan 26th 2020
EXTRACT: "Gibson’s diagnosis is supported by international attitude surveys. One found that most Americans rarely think about the future and only a few think about the distant future. When they are forced to think about it, they don’t like what they see. Another poll by the Pew Research Centre found that 44% of Americans were pessimistic about what lies ahead. But pessimism about the future isn’t just limited to the US. One international poll of over 400,000 people from 26 countries found that people in developed countries tended to think that the lives of today’s children will be worse than their own. And a 2015 international survey by YouGov found that people in developed countries were particularly pessimistic. For instance, only 4% of people in Britain thought things were improving. This contrasted with 41% of Chinese people who thought things were getting better."
Jan 24th 2020
EXTRACT: "........while over 80% of the ECB scheme buys government and other public sector bonds, a huge chunk still goes into corporate bonds and other assets. At the time of writing, the ECB holds €263 billion worth of corporate bonds – a very significant amount in relation to individual firms and the sectors in question. According to the ECB, 29% of these bonds were issued by French firms, 25% by German firms and 11% each by Spanish and Italian firms. As at September 2017, the sectors they came from included utilities (16%), infrastructure (12%), automotive (10%) and energy (7%)."
Jan 17th 2020
EXTRACT: "Thanks to cutting-edge digital technology, cars are increasingly like “smartphones on wheels”, so manufacturers need to have access to the latest patented 4G and 5G technologies essential to navigation and communications. But often the companies that hold the patents are reluctant to license them because manufacturers will not accept the high fees involved, which leads to patent disputes and licensing rows."
Jan 13th 2020
EXTRACT: "Recent polling from Pew Research demonstrates how the public’s attitudes toward the US and President Trump have witnessed sharp declines in many nations across the world. In Europe, the Americas, and the Middle East favorable attitudes toward the US went from lows during the years of George W. Bush’s presidency to highs in the early Obama years to lows, once again, in the Trump era. And in our Zogby Research Services (ZRS) polling we found, with a few exceptions, much the same trajectory across the Middle East."
Jan 13th 2020
EXTRACT: "In the absence of a declaration of war against Iran, the killing of a foreign official – by a drone strike on Iraqi territory – was possibly illegal. But such niceties do not perturb Trump. The evidence is that Trump’s decision was taken without consideration of the possible consequences. The national security system established under Dwight D. Eisenhower, designed to prevent such reckless measures, is broken to non-existent, with ever-greater power placed in the hands of the president. If that president is unstable, the entire world has a very serious problem."
Jan 9th 2020
EXTRACT: "It is possible that Trump’s reverential base won’t be sufficient to keep him in the White House past 2020. But such ardent faith is hard to oppose with rational plans to fix this or that problem. That is why it is so unsettling to hear people at the top of the US government speak about politics in terms that rightly belong in church. They are challenging the founding principles of the American Republic, and they might actually win as a result."
Jan 7th 2020
EXTRACT: "If anything has become clear in our recent Zogby Research Services (ZRS) polling in Iraq, is that most Iraqis are tired of their country being used as a playground for regional conflict, especially the conflict between the US and Iran. In fact, our polling has shown Iraqis increasingly upset with the role played by both the US and Iran in their country. Majorities see both of these countries as having been the major beneficiaries of the wars that have ravaged their nation since the US invaded in 2003. "
Jan 5th 2020
EXTRACT: "Under his [Suleimani's] leadership, Iran helped Hezbollah beef up its missile capabilities, led a decisive intervention to prop up Syrian President Bashar al-Assad, supported the Houthi rebels who have been waging a war against Saudi-led forces in Yemen, and backed a wave of resurgent Shia militias in Iraq. According to Gadi Eizenkot, who completed his term as the Israel Defense Forces’ chief of general staff last year, Suleimani had plans to amass a proxy force of 100,000 fighters along Syria’s border with Israel."
Dec 31st 2019
EXTRACT: ".....stunning technological progress during the 2010s makes it possible to cut GHG emissions at a cost far lower than we dared hope a decade ago. The costs of solar and wind power have fallen more than 80% and 70%, respectively, while lithium-ion battery costs are down from $1,000 per kilowatt-hour in 2010 to $160 per kWh today. These and other breakthroughs guarantee that energy systems which are as much as 85% dependent on variable renewables could produce zero-carbon electricity at costs that are fully competitive with those of fossil-fuel-based systems."
Dec 31st 2019
EXTRACT: "Predicting the next crisis – financial or economic – is a fool’s game. Yes, every crisis has its hero who correctly warned of what was about to come. And, by definition, the hero was ignored (hence the crisis). But the record of modern forecasting contains a note of caution: those who correctly predict a crisis rarely get it right again. The best that economists can do is to assess vulnerability. Looking at imbalances in the real economy or financial markets gives a sense of the potential consequences of a major shock. It doesn't take much to spark corrections in vulnerable economies and markets. But a garden-variety correction is far different from a crisis. The severity of the shock and the degree of vulnerability matter: big shocks to highly vulnerable systems are a recipe for crisis. In this vein, the source of vulnerability that I worry about the most is the overextended state of central-bank balance sheets. My concern stems from three reasons."
Dec 14th 2019
EXTRACT: "Conspiracy theories about sinister Jewish power have a long history. The Protocols of the Elders of Zion, a Russian forgery published in 1903, popularized the notion that Jewish bankers and financiers were secretly pulling the strings to dominate the world. Henry Ford was one of the more prominent people who believed this nonsense."
Dec 13th 2019
EXTRACT: "In previous British elections, to say that trust was the main issue would have meant simply that trust is the trump card – whichever leader or party could secure most trust would win. Now, the emerging question about trust is whether it even matters anymore."
Dec 5th 2019
EXTRACT: "Europe must fend for itself for the first time since the end of World War II. Yet after so many years of strategic dependence the US, Europe is unprepared – not just materially but psychologically – for today’s harsh geopolitical realities. Nowhere is this truer than in Germany."
Nov 23rd 2019
Extdact: "The kind of gratitude expressed by Vindman and my grandfather is not something that would naturally occur to a person who can take his or her nationality for granted, or whose nationality is beyond questioning by others. Some who have never felt the sharp end of discrimination might even find it mildly offensive. Why should anyone be grateful for belonging to a particular nation? Pride, perhaps, but gratitude? In fact, patriotism based on gratitude might be the strongest form there is."
Nov 20th 2019
Extract: "Moody’s, one of the big three credit rating agencies, is not upbeat about the prospects for the world’s debt in 2020 – to put it mildly. If we were to try to capture the agency’s view of where we are heading on a palette of colours, we would be pointing at black – pitch black."
Nov 17th 2019
Extract: "Digital money is already a key battleground in finance, with technology firms, payment processing companies, and banks all vying to become the gateway into the burgeoning platform-based economy. The prizes that await the winners could be huge. In China, Alipay and WeChat Pay already control more than 90% of all mobile payments. And in the last three years, the four largest listed payment firms – Visa, Mastercard, Amex, and PayPal – have increased in value by more than the FAANGs (Facebook, Apple, Amazon, Netflix, and Google)."
Nov 14th 2019
Extract: "Trump, who understands almost nothing about governing, made a major mistake in attacking career public officials from the outset of his presidency. He underestimated – or just couldn’t fathom – the honor of people who could earn more in the private sector but believe in public service. And he made matters worse for himself as well as for the government by creating a shadow group – headed by the strangely out-of-control Rudy Giuliani, once a much-admired mayor of New York City, and now a freelance troublemaker serving as Trump’s personal attorney – to impose the president’s Ukraine policy over that of “the bureaucrats.” "
Nov 4th 2019
Extract: "Trump displays repeated and persistent behaviours consistent with narcissistic personality disorder and antisocial personality disorder. These behaviours include craving for adulation, lack of empathy, aggression and vindictiveness towards opponents, addiction to lying, and blatant disregard for rules and conventions, among others." The concern is that leaders with these two disorders may be incapable of putting the interests of the country ahead of their own personal interests. Their compulsive lying may make rational action impossible and their impulsiveness may make them incapable of the forethought and planning necessary to lead the country. They lack empathy and are often motivated by rage and revenge, and could make quick decisions that could have profoundly dangerous consequences for democracy.
Oct 31st 2019
EXTRACT: "......let’s see what happens when we have less money for all the things we want to do as a country and as individuals. Promises and predictions regarding Brexit will soon be tested against reality. When they are, I wouldn’t want to be one of Johnson’s Brexiteers."
Oct 21st 2019
EXTRACT: "Were Israel to be attacked with the same precision and sophistication as the strike on Saudi Arabia, the Middle East would be plunged into war on a scale beyond anything it has experienced so far. Sadly (but happily for Russian President Vladimir Putin), that is the reality of a world in which the US has abandoned any pretense of global leadership."