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Unlearned lessons from the past are pushing the public debt to record highs

Autor: Article based upon analysis from Reuters Breakingviews
2 min

Public debt now represents close to 40 percent of the global total, the most in almost six decades, according to the International Monetary Fund (IMF).

The debt of governments, companies, and households reached 256% of global GDP by the end of 2020, from 195% in 2007.

Now the war in Ukraine is adding risks to unprecedented levels of public borrowing while the pandemic is still straining many government budgets.

“During the pandemic, deficits increased and debt accumulated much faster than they did in the early years of other recessions, including the largest: The Great Depression and the Global Financial Crisis. The scale is comparable only to the two 20th century world wars”, says IMF.

Global financial conditions are tightening as major central banks raise interest rates to contain inflation. In most emerging markets, sovereign spreads are already above pre-pandemic levels.

The credit crunch is exacerbated by declining overseas lending originating from China.

The debt is harder and harder to be financed, causing economic stress, especially in Europe, China, and the Global South.

There are three main reasons for increasing debt: the financial system’s bailout when the subprime crisis occurred, the supporting schemes during the pandemic, and, now, exploding energy prices.

debt

Source IMF

Chip money, big problems

The repeated quantitative easing made in the West was aimed at preventing an economic slump.

But that resulted in cheap money that everybody leveraged up. Most of the money was used for consumption, instead of productive investment.

China’s excess property construction is a prime example of unproductive investment. The country’s debt as a proportion of GDP has doubled since 2007, according to the IMF.

In Europe, the government did little to target subsidies at the most vulnerable during the pandemic, instead offering massive support to fund consumption.

This happens again during the energy crisis.

In the past decade, global debt has risen by $90 trillion, whereas GDP has grown by only $20 trillion, according to Sonja Gibbs, who leads the Institute of International Finance’s (IIF) debt policy work, cited by Reuters.

Risky behavior was encouraged by cheap money pushed into the markets, where investors were funding long-term assets with short-term borrowing.

The pension fund industry and house market are only some of the areas hit by the perverse effects of QE. Since the era of cheap money is over, other troubles are bound to emerge.

Interest rates are pushed up

Debt investors and central banks alike are pushing up interest rates, in an attempt to restrain inflation.

The sharp fall in British sovereign bonds last week before the Bank of England stepped in is the first big sign of this in rich countries.

Investors do not trust Liz Truss’ mini-budget, because she is borrowing to cut taxes as well as to cushion consumers from high energy prices.

Those who deal with money for a job are skeptical of politicians that do not seem to be watching for the consequences of rising debt.

The UK is at risk, but also Italy and Greece. These countries might have to face big economic problems again because of their high ratios of debt to GDP.

On the other hand, the US is somehow protected, mostly due to its reserves of shale gas. The dollar is not doing bad also and will help the US stop inflation faster than others.