Is a global debt crisis coming? | CNBC Explains

Total

global

debt

has never been higher. And yet, there are few signs of this current wave receding any time soon. Now that the coronavirus outbreak has been declared a pandemic, governments have announced hundreds of billions of dollars in stimulus packages that will further increase

debt

. So how worried should we be if everything falls apart? Global debt has been growing rapidly, so fast that many worry it is be

coming

unsustainable. The Institute of International Finance estimates that total

global

debt, which is made up of loans from households, businesses and governments, rose to a staggering $253 trillion as of the end of September 2019.

That's a huge amount of debt, plus three times the annual economic debt. production of the entire world. This is equivalent to approximately $32,500 of debt for each of the 7.7 billion people on the planet. What's more, the group affirms that this figure will only increase. The World Bank believes that the speed and scale of this wave of debt is something that should concern us all. To such an extent that the group has urged governments around the world to make it a primary concern. But let's take a step back. Simply put, debt is created when one party borrows from another.

It allows people to buy something they normally couldn't afford. That has its benefits. For example, you might go into debt when you get a loan to buy a car or a mortgage for a home. This allows you to pay off the cost of those investments over time rather than paying it all at once. The cost of this service is the interest rate. Currently, interest rates around the world have fallen to historically low levels. This has made borrowing money from banks cheap, meaning businesses can make large investments and homeowners don't need to spend as much on their monthly mortgage payments.

However, a low rate environment has its downsides. Individuals are not likely to get a great return on their savings, and both individuals and companies could accumulate too much cheap debt, something we are seeing now. Governments also take on debt, which they can use to stimulate the economy by funding infrastructure projects, social programs, and more. The amount owed by a country's government is known as sovereign debt. Sovereign debt is very different from how we might think about debt as an individual. But one thing they both have in common is that problems tend to arise when debt becomes excessive.

Loans to countries with developed economies, such as Canada, Denmark or Singapore, are generally considered safe investments. That's because even if governments spend beyond their means, lawmakers can raise taxes or print more money to make sure they pay what they owe. But loans to emerging market governments are generally considered much riskier, which is why these countries sometimes issue debt in a more stable foreign currency. Although this allows them to attract more foreign investors seeking higher returns, an economic

crisis

, a weak local currency or a high debt load can make it difficult for the government to pay them.

Ultimately, the most important risk when it comes to national borrowing is that a country could fall behind on its debt obligations and default on its obligations. This is not common but it has happened. Take Lebanon in 2020, Argentina in 2001, and Russia in 1998. Over the past 50 years, there have been four waves of debt accumulation. We are currently in the middle of the fourth wave. So what can we learn from the first three? Well, for starters, none of them had a happy ending. Let's start with the first wave. In the 1970s, many Latin American countries began borrowing large amounts of money from American commercial banks and other creditors to support their development.

At the time it didn't seem like a problem. Interest rates were low and Latin American economies were flourishing. But deep down, the wave of debt was increasing. At the end of 1970, the region's total outstanding debt from all sources amounted to $29 billion. By the end of 1978, that figure had skyrocketed to $159 billion. Four years later, it had more than doubled to $327 billion. In the 1980s, major economies began raising their interest rates as they battled inflation. Oil prices were falling and the world economy was entering a recession. In 1982, the starting signal for the Latin American debt

crisis

was effectively fired, when Mexico announced that it would not be able to pay its debts.

This measure quickly caused a region-wide collapse, the consequences of which spread to dozens of emerging economies around the world. Many Latin American countries were forced to devalue their currencies to keep export industries competitive in the face of a severe economic crisis. Between 1981 and 1983, Argentina weakened its currency against the US dollar by 40%, Mexico by 33%, and Brazil by 20%. In the end, 27 countries had to restructure their debts. Sixteen of them were in Latin America. The second wave lasted from 1990 to the early 2000s. It differs from the first in that the accumulation of debt in the private sector played a much more prominent role.

In the late 1980s and early 1990s, many advanced economies deregulated their financial markets. Policy changes led to the consolidation of many banks and the operations of these larger banks became increasingly global. This helped spark a massive surge of capital into emerging markets, with falling interest rates and a slowdown in advanced economies also fueling the surge. Developing economies began to accumulate large debts, especially Indonesia, South Korea, Malaysia, the Philippines and Thailand. However, this rising wave of debt went largely unnoticed. You see, debt was growing rapidly, but so was GDP, meaning the ratio between the two remained constant.

And most of the debt was hidden in the private sector. A currency crisis in Mexico in 1994 sent international investors back into panic mode, while the country's default a decade earlier was still fresh in people's minds. However, while a $50 billion bailout from the United States and the IMF meant Mexico narrowly avoided a default this time, it was not enough to stop the panic from spreading to other countries. It led to an abrupt stop and reversal of capital flows in 1997. By that time, Indonesia, South Korea, Malaysia, the Philippines and Thailand had developed a dependence on debt. Coupled with various political failures, this contributed to a crisis in the East Asian financial sector and, ultimately, another global crisis.

While those affected by the Asian financial crisis recovered, international indebtedness continued at a rapid pace. Enter the third wave of global debt, which lasted from 2002 to 2009. At the end of the previous century, the United States removed barriers between commercial and investment banks, while the European Union encouraged cross-border connections between lenders. This paved the way for the formation of so-called “megabanks.” These banks led the way in a sharp increase in private sector borrowing, particularly in Europe and Central Asia. Defaults in the US subprime mortgage system piled more and more pressure on the country's financial system, bringing it to the brink of collapse in the second half of 2007 and 2008.

The shock waves reverberated around the world, with one economy after another falling into a deep, albeit short-lived, recession. In the United States, the 2009 recession was so severe that output in the world's largest economy sank to its lowest level since the Great Depression. The World Bank says we are currently in the midst of the fourth wave of global debt. And to prevent history from repeating itself once again, governments must make debt management and transparency a top priority. This wave of global debt is believed to share many of the same characteristics as the previous three, including prolonged periods of low interest rates and changing financial landscapes that encourage greater borrowing.

But the World Bank has called the current wave "the largest, fastest and most broad-based" of all. It involves a simultaneous accumulation of both public and private debt, involves new types of creditors and is much more global. Although the coronavirus pandemic threatens to sink the global economy, the time to stem the tide may have passed.