VENDREDI 06 MARS 2020 BIZWEEK ÉDITION 280 The seeds of the next debt crisis The shock that coronavirus has wrought on markets across the world coincides with a dangerous financial backdrop marked by spiralling global debt. According to the Institute of International Finance, a trade group, the ratio of global debt to gross domestic product hit an all-time high of over 322 per cent in the third quarter of 2019, with total debt reaching close to $253tn. The implication, if the virus continues to spread, is that any fragilities in the financial system have the potential to trigger a new debt crisis. In the short termthe behaviour of credit markets will be critical. Despite the decline in bond yields and borrowing costs since the markets took fright, financial conditions have tightened for weaker corporate borrowers. Their access to bond markets has become more difficult. After Tuesday’s 50 basis-point cut, the US Federal Reserve’s policy rate of 1.0-1.5 per cent is still higher than the 0.8 per cent yield on the policy-sensitive two-year Treasury note. This inversion of the yield curve could intensify the squeeze, says Charles Dumas, chief economist of TS Lombard, if US banks now tighten credit while lending has become less profitable. This is particularly important because much of the debt build-up since the global financial crisis of 2007-08 has been in the non-bank corporate sector where the current disruption to supply chains and reduced global growth imply lower earnings and greater difficulty in servicing debt. In effect, the coronavirus raises the extraordinary prospect of a credit crunch in a world of ultra-low and negative interest rates. Global debt hits a record high $in 250 200 150 100 50 2000 01 02 03 04 05 06 07 08 09 1 Source IIF e or ACTA PUBLICA COVID-19 With debt levels already at a record high, coronavirus raises the risk of a credit crunch in a world of low interest rates Share of GDP (%).". I 12 13 14 15 16 17 18 19 Policymakers Policymakers in advanced countries in advanced have over the countries past week made clear have their over readiness the to past week pursue an made active fiscal clear and monetary their response readiness to the disruption to pursue caused by the an virus. active Yet such fiscal and policy monetary activism carries a longer-termresponse risk of to entrenching the disruption the dysfunctional monetary caused policy by that the virus. contributed to the original financial crisis, as wellas exacerbating the dangerous debt overhang that the Yet global such economy policy now faces. activism carries a longer-termrisk of entrenching the dysfunctional monetary policy that contributed banks — to and the especially original the Fed — financial conducted what crisis, came to as be well known as « asymmetric exacerbating The risks have been building in the financial system for decades. From the late 1980s, central the monetary dangerous policy », whereby debt they supported overhang markets that when they plunged global but failed economy to damp now them down when they were prone to bubbles. Excessive risk taking in banking was the natural faces. consequence. The central banks’quantitative easing since the crisis, which involves the purchase of government bonds and other assets, is, in effect, a continuation of this asymmetric approach. The resulting safety net placed under the banking system is unprecedented in scale and duration. Continuing loose policy has brought forward debt financed private expenditure, 350 300 250 200 150 100 50 The risks have been building in the financial system for decades. From the late 1980s, central banks — and especially the Fed — conducted what came to be known as « asymmetric monetary policy », whereby they supported markets when they plunged but failed to damp them down when they were prone to bubbles. Excessive risk taking in banking was the natural consequence. The central banks’quantitative easing since the crisis, which involves the purchase of government bonds and other assets, is, in effect, a continuation of this asymmetric approach. The resulting safety net placed under the banking system is unprecedented in scale and duration. Continuing loose policy has brought forward debt financed private expenditure, thereby elongating an already protracted cycle in which extraordinary low or negative interest rates appear to be less and less effective in stimulating demand. William White, who while head of the monetary and economics department at the Bank for International Settlements in Basel was one of the few economists to predict the financial crisis, says the subsequent great experiment in ultra-loose monetary policy is intensely morally hazardous. This, he argues, is because unconventional central bank policies may « simply set the stage for the next boom and bust cycle, fuelled by ever declining credit standards and ever expanding debt accumulation ». A comparison of today’s circumstances with the period before the financial crisis is instructive. As wellas a big post-crisis increase in government debt, an important dif- Cont’d on page 5 4 |