The ancient Babylonian kings had a special tool when economic or social conditions got risky: they declared a “debt jubilee” and instantly wiped out loans from borrowers, allowing average struggling people to start over with a clean slate.
It says a lot about the global economy in 2016 that the concept of a modern debt jubilee caught on in some general discussions on financial markets.
Eight years ago, unsustainable debt caused the worst recession since the Great Depression. Yet aggregate global debt is now well above 2008 levels. And like millions of American buyers at the time, many borrowers today owe amounts that could become an overwhelming burden if l he world economy was sinking into another recession.
The overwhelmed include many governments. The total outstanding global public debt was worrying in 2008. It has since doubled to $ 59 trillion, according to Economist Intelligence.
But that’s only a slice of the global debt pie. Add to that the debt of households, businesses and banks and the total stood at $ 199 trillion in mid-2014, up 40% since 2007, according to a study carried out last year by McKinsey World Institute.
One of the most dramatic increases has been American student debt. University loan stocks climbed to $ 1.35 trillion from $ 589 billion in 2007, a 130% jump, according to Federal Reserve data. This extraordinary burden on young people became a political problem in the presidential election, at least for Democratic rivals Hillary Clinton and Bernie Sanders.
The irony for students and other borrowers over the past eight years is that many have done exactly what governments and central banks wanted them to do to help end the Great Recession: profit very low interest rates for borrowing and spending.
Since the financial crash, “central bank policies have all been based on the theory that low interest rates will stimulate demand,” said Edward Yardeni, director of market and economic research firm Yardeni Research Inc. “But that theory has now run out.”
The reason: Whatever demand has been stimulated, it has not been enough to prevent the global economy from slowing sharply in recent years. Without the driving force to keep moving forward, the economy simply has not paid off for many people, businesses and governments who borrowed aggressively after 2007.
“The whole world is growing at a much lower level than it was before the crisis,” said Jeffrey Rosenberg, chief fixed income investment strategist at fund management giant BlackRock Inc.
Real world growth was on average only 2.4% per year from 2012 to 2015. In contrast, growth was on average sustained 3.7% from 2001 to 2010, including the years of the Great Recession.
Debt can be a good thing if it is used productively and fuels economic growth, of course. But when the McKinsey study looked at the total debt of governments, households and businesses relative to the size of economies in 47 countries from 2007 to 2014, it found that the ratio had increased in all of them – in some cases considerably.
In the United States, the percentage of debt to gross domestic product reached 233% in 2014, compared to 217% in 2007. In Spain, the figure rose from 241% to 313% and in Japan it fell from 336% to 400%. . There is no single number, but obviously higher is riskier.
As debt has grown, the overall effect has been to stifle growth rather than promote it.
“The problem with high debt levels is that it’s very crippling,” said Kenneth Rogoff, professor of economics at Harvard University who has written extensively on the implications of debt.
In Greece, the flashpoint of the first European public debt crisis in 2009, debt problems remained so heavy for local banks that “if you are a business, you cannot get a loan”, he said. declared Rogoff. This starves the economy even more.
In Italy, where banks are also burdened with bad debts, mounting economic fears over the past two weeks have raised concerns that lenders will soon need new government assistance.
And in the United States, the millennial student loan burden has helped many of them not spend like previous generations did when they were in their 20s to 30s. Consider: For the first time in 130 years, adults between the ages of 18 and 34 are more likely to be living with their parents than married or cohabiting with someone else, according to the Pew Research Center.
This robs the economy of the traditionally high expenses people make when forming a new household – buying things like furniture, televisions, blinds, and dishwasher soap.
For the Federal Reserve and the world’s other major central banks, this year has yet another stark reminder that the economy and markets do not accept the idea that policymakers’ traditional interest rate tools could accelerate growth.
The Fed raised its short-term key rate in December for the first time since 2006, dropping it from near zero to a range of 0.25% to 0.50%. The heart of the Fed’s message was that things were finally getting back to normal in the economy, so rates should go up.
Yet in early January, new fears that the slowdown in the Chinese economy could drag the rest of the world away prompted investors to look to US Treasury bonds as a safe haven, driving yields down sharply. Markets stabilized in the spring, then Treasury yields plunged again in recent weeks after the British people stunned the world by voting to leave the European Union – a move that further undermined confidence in The struggling European economy.
Last week, the yield on 10-year Treasuries hit an all-time high of 1.37%, from 2.27% at the end of last year. In addition, yields are now negative on a wide range of European and Japanese government bonds. A negative return means that instead of earning interest, investors agree to pay the government a small amount to keep their money safe in bonds.
The yield on German 10-year government bonds was negative 0.18% on Friday; on Japanese 10-year bonds it was negative 0.29%.
One of the messages from negative interest rates is that some investors fear worse economic turmoil. This, in turn, raises concerns about the ability of borrowers to repay their lenders. Psychologically, “the debt is becoming like a black cloud outside your door,” said Mohamed El-Erian, chief economic adviser at financial services firm Allianz.
This time around, American homeowners are unlikely to lead a debt crisis. But there are other candidates, especially companies from emerging countries. Since 2008, “the most worrying development has been the sharp increase in private sector debt … especially in several emerging market economies,” warned the Bank for International Settlements, which is owned by the world’s central banks. a report in March.
More than 5,200 emerging market companies issued bonds worth $ 1.1 trillion in 2014, double the level sold in 2010, according to Dealogic. Part of this sum was used to finance or refinance more manufacturing or production capacity of raw materials. But in a context of weak global growth, adding new factories or new raw material supplies can reduce profits for each player.
“The problem is what you created with the debt,” said Steven Ricchiuto, chief US economist for Mizuho Securities. “The fundamental problem is that we have an oversupply. “
But will this necessarily lead to another “crisis”? BlackRock’s Rosenberg notes that some kind of global debt explosion has occurred about every seven or eight years since the early 1980s. That means 2016 would be as expected.
Inevitably, some banks and investors lose when lending money. It is capitalism. The financial system is set up to deal with losses, on a modest scale, through foreclosure and bankruptcy laws.
The question is whether the global economy has reached a point where something more drastic is needed to revive growth, such as the Babylonian solution to mass debt cancellation.
At first glance, the idea of a “debt jubilee” seems absurd. Unilaterally writing off debt would also mean wiping out the assets of countless lenders and investors, including pension funds. When loan losses during the Great Recession threatened to destroy the banking system, the US and European governments stepped in with taxpayer money to save it – and swore “never again”.
Still, many experts believe debt cancellation for some desperate senior borrowers is now a certainty. Greece, which owes $ 359 billion, tops the list.
From a practical standpoint, “debt cancellation is really, really hard,” El-Erian said. “There are huge equity issues. But for Greece today, the alternative is worse. This alternative is the probability that the economy would remain in ruins.
Puerto Rico clearly also cannot repay the $ 70 billion it owes, Rogoff said.
Democratic presidential candidates Clinton and Sanders have both offered ways to ease the burden on federal college loans, primarily by speeding up debt refinancing at lower interest rates. It is a discount in the sense that the government would earn less on the loans.
Many economists believe the world can continue to cope with high debt and slow growth for a while. This helps central banks to have bought trillions of bonds since 2007 to ease the burden on governments. The crucial test will come if the global economy slides into another recession sooner rather than later.
With debt levels so high and interest rates already close to zero or lower, the pressure would increase on central banks to use what Wall Street sees as the nuclear option: to start printing mountains of money. money for governments to give directly to consumers – to spend, pay off debts or save without strings attached.
The political and economic risks of such a movement would be enormous – which is why it would only be seen as a movement of desperation.
For central banks, “this is the last breath,” Rosenberg said.