A little more than a decade after the 2008 financial crisis that shocked the global economy leading to unprecedented recession, unemployment, banking chaos and debt insecurity seemed to be back to normal. Global GDP has been rising ever since, international trade was up, the financial system regained its stability and credibility and the economies around the world have been recording higher output and record-low unemployment with better paid jobs.
And then covid-19 pandemic struck. Lockdowns and other hard measures implemented to limit the spread of the virus have left their mark on every economy. A health crisis has turned into an economic collapse. Trade and business have been hurt badly, as free movement of people and goods was restrained, businesses closed or even bankrupted and consumption fell significantly. That means thousands and thousands of jobs have been lost and more families are on the verge of poverty and economic insecurity. States have lost billions in revenues and their fiscal position has deteriorated quickly. Meanwhile, government-enforced shutdowns brought another obligation for welfare policies in order to protect citizens who were economically inflicted by these measures. This means more government spending with budgets going off track leading to additional capital needs. Consequently, this economic downfall can progressively lead to a new debt crisis. That’s the scope of this article. How can we prevent another global debt crisis that would crash the whole financial and banking system again leading to more poverty and desperation?
Actually both public and private debt have been rising globally since the 2008 crisis, following increased government spending policies where it was possible, while in other countries facing financial difficulties, insecurity led to extended debt restructuring procedures pushing payments in the future and thus increasing state indebtedness. Going back into recession would uncover the weak point of our financial system and increase the possibility of a new wave of financial insecurity for many countries around the world, as indicated by government bonds markets during the pandemic. Global debt, as I am writing this piece, has exceeded 60 trillion (!) dollars and has almost doubled since 2008, when it was estimated at 32 trillion dollars. All the basic macroeconomic indicators show that the size of the global economy might be just a bubble. It seems like we are already exceeding potential through leverage and extreme indebtedness and this quite as well can come crashing down, as we have witnessed in the past.
At the same time, due to the low interest rates following the previous financial crisis, the private sector and big businesses have also built their growth on borrowing and leverage, aiming for higher yields in their various productive or financial investments. This has happened at an accelerating rate over the course of the last decade and doubts have been raised about its viability on the long term. According to an IMF article during the last quarter of 2019, the corporate debt of eight of the strongest economies in the world – US, China, Japan, Germany, UK, France, Italy and Spain – was estimated around 51 billion dollars, while this was only 34 billion back to 2009, in the midst of the financial crisis! More importantly, the IMF projected that in case of a new depression almost 40% of this debt might turn into non-performing loans, which means defaulting. That is exactly where we are right now, as covid-19 pandemic results in economic downturn and ultimately recession. The progressive indirect effects on debt credibility worldwide are yet to be seen, but definitely another severe debt crisis might be occurring at some point in the future.
The ultimate question is what we can do to prevent or control the extent of an upcoming public or private debt crisis. On the one hand, private debt can be dealt with in a more comfortable manner. There are solutions already exercised that can be extended and universally used, like the extension of repayment periods or outright haircuts. The final measure could be the establishment of a global “Bad Bank” that would acquire some of the most important unsecured loans of big corporations, banks and private citizens, in an effort to facilitate their repayment under favorable term settlements. This should also happen domestically within countries to secure the stability of the banking systems, providing borrowers the help needed in these troubling times so that they can ultimately repay their loans.
On the other hand, the case of government debt is not that easy, as many countries are in debt to others and this makes it a rather complex effort. But with the circumstances looking more and more gloomy, what about a global debt relief? A complete multilateral agreement from countries around the world or at World Bank or IMF level for long-term repayment extension or an outright debt haircut, at a certain extent, may as well be an uncontested solution to extreme government indebtedness endangering the world’s financial stability and security. This idea might seem a little aggressive at first look, but if we consider how things stand right now and how they could evolve because of the pandemic, we should think it through. Of course, the immediate repercussions of such an unconventional plan would be harsh, as the markets will not – by any chance – be in favor of, but ultimately the danger of a debt crisis in the foreseeable future would be avoided. We are already on the brink of a huge debt bubble that could end up in a catastrophe.
Devastating memories from the collapse of the global financial and banking system and the respective institutions in 2008 are still present and we should stay alert to predict and prevent another disaster. As things stand, despite high indebtedness, the system looks stable. But what if the pandemic severely affects, as we witness, people, business and government budgets in a way that increases non-performing loans leading to a global debt crisis? As we have learned from the 2008 crisis, a little “flame” can spark a disastrous “fire” of defaults in our globalized financial system. In this case, decisive actions, like the ones proposed, might be needed. This article attempts to set the alarm on a potential, upcoming crisis and provide some conventional or unconventional ideas on how we could effectively address it.