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Is a global debt crisis coming? | CNBC Explains

Apr 07, 2020
Total world

debt

has never been higher. And yet there are few signs that this current wave will recede 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 it all comes crashing down? Global indebtedness has been growing rapidly, so rapidly that many worry that it is quickly be

coming

unsustainable. The Institute of International Finance estimates that total

global

debt, which is made up of borrowing by households, businesses, and governments, rose to a staggering $253 trillion as of the end of September 2019.
is a global debt crisis coming cnbc explains
That's a lot of debt, more than three times the annual economic departure from the whole world. That equates to approximately $32,500 of debt for each of the 7.7 billion people on the planet. Furthermore, the group says that this number is only going to increase. The World Bank believes that the speed and scale of this wave of debt is something that should concern us all. So much so, that the group has urged governments around the world to make it a top 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 that they normally couldn't afford.
is a global debt crisis coming cnbc explains

More Interesting Facts About,

is a global debt crisis coming cnbc explains...

That has its benefits. For example, you might get into debt when you take out a loan to buy a car or mortgage a house. This allows you to pay the cost of those investments over time instead of 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 bank lending cheaper, which means businesses can make big investments and homeowners don't need to spend as much on their monthly mortgage payments. However, there are drawbacks in a low rate environment. People aren't likely to see a great return on their savings, and both individuals and businesses could accumulate too much cheap debt, something we're seeing now.
is a global debt crisis coming cnbc explains
Governments also take on debt, which they can use to stimulate the economy by financing infrastructure projects, social programs, and more. A country's government debt 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 borrowing 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.
is a global debt crisis coming cnbc explains
But lending to governments in emerging markets is generally seen as much riskier, which is why these countries sometimes issue debt in a more stable foreign currency. While this allows them to attract more investors from abroad seeking higher returns, an economic downturn, a weak local currency or a high debt load can make it difficult for the government to pay them back. Ultimately, the most important risk when it comes to national borrowing is that a country falls behind on its debt obligations and goes into default. 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 one thing, none of them had a happy ending. Let's start with the first wave. In the 1970s, many Latin American countries began to borrow large amounts of money from US commercial banks and other creditors to support their development. It didn't seem like a problem at the time. Interest rates were low and the Latin American economies were flourishing. But deep down, the wave of debt was mounting.
By the end of 1970, the region's total outstanding debt from all sources was $29 billion. By the end of 1978, that number had ballooned to $159 billion. Four years later, it had more than doubled to $327 billion. In the 1980s, the major economies began to raise their interest rates while fighting inflation. Oil prices fell and the world economy entered a recession. In 1982, the starting gun for the Latin American debt

crisis

was effectively fired, when Mexico announced that it would not be able to pay its debts. This move quickly caused a region-wide collapse, with the fallout spilling over into dozens of emerging economies around the world.
Many Latin American countries were forced to devalue their currencies to maintain the competitiveness of export industries in the face of a severe economic recession. Between 1981 and 1983, Argentina weakened its currency against the US dollar by 40%, Mexico by 33%, and Brazil by 20%. Finally, 27 countries had to restructure their debts. Sixteen of them were in Latin America. The second wave lasted from 1990 to the early 2000s. Unlike the first, the accumulation of debt in the private sector played a much more prominent role. In the late 1980s and early 1990s, many advanced economies liberalized their financial markets. Policy changes led to the consolidation of many banks, and the operations of these larger banks became increasingly

global

.
This helped fuel a massive capital surge in emerging markets, with falling interest rates and a slowdown in advanced economies also fueling the rise. Developing economies began to accumulate a large amount of debt, most notably Indonesia, South Korea, Malaysia, the Philippines, and Thailand. However, this mounting wave of debt went largely unnoticed. You see, debt was growing fast, but so was GDP, which means that 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 into a panic again, with the country's default a decade earlier still fresh in people's minds.
However, while a US$50 billion bailout from the US and the IMF meant that Mexico narrowly avoided default this time, it was not enough to prevent panic from spreading to other countries. It led to an abrupt halt and reversal of capital flows in 1997. By this time, Indonesia, South Korea, Malaysia, the Philippines, and Thailand had developed a dependency on loans. Along with various policy failures, this helped start a crisis in the East Asian financial sector and, ultimately, another global recession. Although those affected by the Asian financial crisis recovered, international borrowing continued apace. 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 among lenders. This paved the way for the formation of the so-called "megabanks". These banks led the way in a sharp increase in private sector lending, particularly in Europe and Central Asia. Defaults in the US subprime mortgage system put increasing 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 US, the 2009 recession was so severe that output in the world's largest economy plunged to its lowest level since the Great Depression. The World Bank says that we are currently in the midst of the fourth wave of global debt. And to prevent history from repeating itself yet 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 more borrowing. But the World Bank has called the current wave "the biggest, fastest and most broad-based" of all.
It implies a simultaneous accumulation of public and private debt, it involves new types of creditors and it is much more global. However, as the coronavirus pandemic threatens to sink the global economy, the time to stem the tide may have passed.

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