Is There a Threat of a New Global Economic Crisis?

The unprecedented debt load of major economies, like the United States, China and the EU is fraught with a disastrous threat for the entire world. This could lead to a disaster that will by far exceed the Great Depression if deleverage starts, Valdai Club expert Alexander Losev warns.

According to the Washington-based Institute of International Finance, global debt reached $246.5 trillion in the first half of 2019, which is about 318 percent of the world’s GDP. This is a little less than the record figure of 2018 but still very close to a historical high. In this aggregate debt, the share of the advanced countries is $177 trillion, and the debt of the developing nations is approximately $69 trillion, also a new record.

However, despite the unprecedented growth of world debt in the past ten years after the 2008 crisis, investment activity in the real economy is declining, growth in the world economy and international trade is slowing and the risk of a global recession is on the rise. The accumulated aggregate debt is becoming a real threat to the stability of the global financial system.

Credit financing has become the main, if not the only means of maintaining global consumer demand and a major impetus for the growth of stock markets and economic advance in general. The post-industrial model with a high level of automation and the transfer of production to countries with cheap labor and profit centers to tax havens has led to a sharp decline in the share of human labor in the end product. Now owners of capital and means of production share much less with their workers and states. Under the circumstances, governments must continuously increase their national debt to finance budget deficits, while the population has to take out loans to maintain existing living standards because of falling revenues.

Economization of Freedom
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The news compass of the Western world, the New York Times, usually writes its headlines in a moderate way. But in the fall of 1989 almost every day the letters were in huge bold print, because the news was not only very important, it was sensational. Why? Because the partition of Europe was coming to an end, day by day, culminating with the fall of the Berlin Wall––the most important symbol of all, because it had divided not only one city, one country, one continent, but the entire world.

Another problem is that now global debt is growing faster than the world economy, and each new percent of economic growth is matched by an additional increase in the aggregate debt by 1.5 – 2 percent. Deceleration of credit financing for various reasons, including a decline in economic activity due to trade wars, a shortage of liquidity and/or interest rate increases could instantly lead to the stagnation of the world economy. It is only the incredibly soft money-and-credit policy of the world’s major central banks that is keeping the entire economic and financial system afloat at this point.

The International Monetary Fund (IMF) noted that corporate debt-at-risk could rise to $19 trillion. In its half yearly report on the condition of world financial markets, the IMF warned that it will be impossible to service almost 40 percent of the corporate debt in the eight leading countries – the United States, China, Japan, Germany, Great Britain, France, Italy and Spain. The IMF notes that adaptive money-and-credit stimulation by central banks has helped companies accept financial risk, which led to “alarming” debt levels with low loan quality.

It will be impossible to continue to expand loan capacity. Moreover, credit cannot eliminate the imbalances of current accounts in major countries, including the United States. Imbalances and a negative trade balance are countered with protectionism and trade wars, which could sink the world into depression very quickly.

Another problem emerged when bank oversight was toughened after the 2008 recession. Bank trade assets dropped by half, interbank loans declined by one third and all of the additional growth in funding came from capital markets where control is much weaker and volatility is higher. But now due to the continuous infusion of liquidity by central banks, new bubbles are appearing on the stock markets and companies are recording growing business based on credit demand. They are buying stocks with super-cheap money because they gain more by borrowing for their operation than using the stock market to attract capital. That said, institutional investors and funds have accumulated assets worth some $30 trillion. A very high share of them is high-risk and illiquid.

The unprecedented debt load of major economies, like the United States, China and the EU is fraught with a disastrous threat for the entire world. This could lead to a disaster that will by far exceed the Great Depression if deleverage starts. In effect, this happens when a credit bubble bursts. A deleverage could happen not because banks will run out of money for new loans but because borrowers may not have an opportunity to refinance debt and redeem loans. As the 2007-2008 America mortgage crisis showed, defaults totaling $1.3 trillion could trigger a domino effect with mass-scale bankruptcies and blowout sales of collateral that’s rapidly losing its value.

Since the global debt has reached $246.5 trillion, neither governments nor central banks will have enough resources to repurchase liabilities and write off debt as they did during the 2008 crisis when they helped banks, pension and investment funds, companies and individuals that were rapidly losing assets. In addition, considering that the market for currency and loan derivatives exceeds $600 trillion (about $545 trillion in the United States alone), it’s clear that there are several ticking bombs.

It is only a matter of time before a disastrous crisis makes the Great Depression of the 1930s and the 2008 recession seem mild. The scenario for a new crisis depends on the ability of the monetary authorities to take timely or even preventive measures and on the extent of international cooperation between governments and central banks of various countries.

The financial world is interconnected. The US market plays a key role and the US Federal Reserve is, in effect, the world’s main central bank. Globalization in the past few decades, that benefited the United States for a long time, established not only a geopolitical structure over the US-controlled global economic foundation but also created a universal mechanism for controlling investment flows, capital movement and global trade by using the dollar as the currency of international transactions and reserves.

The prices on stock, currency and raw materials exchanges are now based less on supply and demand and more on the amount of available fund liquidity. Prices rely on interest rates and loan costs and depend on the routes of financial flows and the availability of dollars for investors and profiteers. Almost a decade of near-zero interest rates in the United States has encouraged companies all over the world to borrow in dollars, which made the global economy even more dependent on the US Federal Reserve’s monetary policy. At the same time, very low interest rates in advanced countries have compelled investors to seek income in the developing markets and buy more risky shares and illiquid assets to gain profits.

Thus, the global economy is now threatened by the seven swords of Damocles simultaneously: (1) a global credit market bubble; (2) the condition of the US economy on which Federal Reserve actions depend; (3) a potential crisis of overproduction of industrial goods, including in Germany and China; (4) the US trade and technological confrontation with China and other countries; (5) the risk of recession in the advanced states; (6) the behavior of the markets; and, (7) the financial and economic health of the developing nations. We will see fairly soon which risk will be the first to materialize.

To prevent cyclic crises in the future it will be necessary to carry out structural changes in the world economy, such as the creation of several comparable monetary centers – financial and economic poles that can support the entire structure of the global economy, global multi-currency reserves and mutual transactions in trade between countries, and the tougher regulation of loans and tax management.

With a strong state budget structure, conservative financial policy, low debt and a flexible money-and-credit policy, Russia is much better prepared for a world crisis than the majority of other countries. However, structural weaknesses in the Russian economy make it vulnerable if prices on raw materials fall as a result of a global decline. Before the onset of a crisis it is very important to expedite the implementation of infrastructure and other national projects and reindustrialize processing industries with a view to diversifying the Russian economy and closing some of the added value chains inside the country to prevent a breakup by a global crisis.

Views expressed are of individual Members and Contributors, rather than the Club's, unless explicitly stated otherwise.
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