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The worrisome US$247 trillion global debt bomb

THE untold story of the world economy - so far at least - is the potentially explosive interaction between the spreading trade war and the overhang of global debt, estimated to be at a staggering US$247 trillion. That's "trillion" with a "t". The numbers are so large as to be almost incomprehensible.

Households, businesses and governments borrow on the assumption that they will service their debts either by paying the principal and interest or by rolling over the debts into new loans. But this works only if incomes grow fast enough to make the debts bearable or to justify new loans. When those ingredients go missing, delinquencies, defaults and panic follow.

Here's where the trade war and debt may intersect disastrously. Since 2003, global debt has soared. As a share of the world economy (gross domestic product), the increase went from 248 per cent of GDP to 318 per cent. In the first quarter of 2018 alone, global debt rose by a huge US$8 trillion. The figures include all major countries and most types of debt: consumer, business and government.

But to service these debts requires rising incomes, while an expanding trade war threatens to squeeze incomes. The resort to more tariffs and trade restrictions will make it harder for borrowers to pay their debts. At best, this could slow the global economy. At worst, it could trigger another financial crisis.

Note that the danger is worldwide. It's not specific to the United States. In a new report, the Institute of International Finance (IIF), an industry research and advocacy group, says that the debts of some "emerging market" countries (Turkey, South Africa, Brazil, Argentina) seem vulnerable to roll-over risk: the inability to replace expiring loans. In 2018 and 2019, about US$1 trillion of dollar-denominated emerging-market debt will mature, the IIF says.

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Debt can either stimulate or retard economic growth, depending on the circumstances. Now we're approaching a turning point, according to Hung Tran, the IIF's executive managing director. If debt growth is not sustainable, as Mr Tran believes, new lending will slow or stop. Borrowers will have to devote more of their cash flow to servicing existing debts.

At a briefing, Mr Tran described the change this way:

"(We had) a goldilocks economy, with decent economic growth. Inflation was nowhere to be seen, allowing central banks such as the Federal Reserve and the European Central Bank to be more accommodative, that is, keeping interest rates low. You could always roll over your debt. However, the probability of this continuing is much less now. ... Trade tensions are on the rise, and this has already impacted business confidence and the willingness to invest."

Inflation is also creeping up. To stall its rise, the Fed is raising interest rates. Trade protectionism compounds the problem, because many non-US companies borrow in dollars. (Dollars are widely used in trade even if neither the importer nor the exporter is American.) But these loans must be repaid in dollars. If tit-for-tat protectionism dampens trade, getting those dollars will become harder. Loan delinquencies and defaults may rise.

Mr Tran isn't predicting a full-scale panic resembling the 2008-09 financial crisis, and there are some reasons for optimism. Banks are better capitalised now than before the crisis. (Bank capital - shareholders' funds or loans - protects against losses.) People are also more sensitive to the dangers compared to a decade ago.

Evidence of this comes from a recent "stress test" performed on 35 large bank-holding companies by the Fed. A deep recession was simulated; the unemployment rate rose to 10 per cent. Despite large losses, no bank failed. Since 2009, these banks have added US$800 billion in common equity capital, says the Fed.

What Mr Tran is suggesting is a global shift away from debt-financed economic growth. The meaning of the US$247 trillion debt overhang is that many countries (including China, India and other emerging-market economies) will be dealing with the consequences of high or unsustainable debts - whether borne by consumers, businesses or governments. There will be a collective impact on the global economy.

"If you are in a high-debt situation, you need to bring the debt down, either absolutely or as a share of GDP," he said at the briefing. "This will result in slower economic growth. You don't have the borrowing needed to maintain strong investment and consumer spending."

This may represent a final chapter to the 2008-09 financial crisis. The low interest rates adopted by central banks were justified as necessary to avoid a worldwide depression. Critics worried that cheap credit would rationalise risky lending that wouldn't survive higher rates. We may soon discover who is right. THE WASHINGTON POST WRITERS GROUP

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