Government debt is soaring to levels not seen since the “rubble and smoke of 1945” says The Economist. “As the economy falls into ruins,” the IMF forecasts that deficits in advanced economies will run at an average of 11% of GDP this year. That will propel the total stock of public debt in rich countries to an average of 122% of GDP by year’s end, with US debt set to break wartime records and Italian public debt likely to hit 155% of GDP.
The global debt mountain
Global balance sheets are ill-prepared for recession. At over $255trn, the total debt of governments, households and corporations is equivalent to 322% of GDP, 40% higher than on the eve of the 2008 crisis according to data from the Institute of International Finance. With governments now issuing vast tranches of bonds to fight Covid-19, that figure could climb above 342% by year’s end.
It’s not only state borrowing, says Jefferson Frank for theconversation.com. Companies are entering the pandemic with historically high levels of leverage; US corporate debt is equivalent to more than 70% of GDP. Credit-ratings agency Fitch forecasts a doubling in defaults this year on US leveraged loans to 5%-6%. “For retail and energy companies, the default rate could approach 20%.”
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Much of the global borrowing binge is being financed indirectly through central bank bond purchases with printed money. Asset manager Unigestion reports that the combined value of the Federal Reserve and European Central Bank’s balance sheets alone is equivalent to about 13% of global GDP and rising thanks to the “abundant” liquidity provided to fight the crisis.
The debt pile is manageable for now, says The Economist, thanks to rock-bottom interest rates: America spent less of its GDP on servicing its debt pile in 2019 than it did 20 years ago. The current situation is not unprecedented: British public debt reached 259% of GDP at “its wartime height”. That pile was subsequently whittled down through a “bossy combination” of high taxes, financial repression and inflation.
Deflation, then inflation?
We could well see a jump in inflation this time too. The short-term outlook is undoubtedly deflationary, says Randall Forsyth for Barron’s. Plunging crude oil prices and mass unemployment are hardly a recipe for a wage-price inflationary spiral. Yet come 2022 things could look quite different. Globalisation has depressed the prices of wages and goods in recent decades, but now it is going into reverse. The crisis has made more companies willing to pay up for the security of running shorter, more local supply chains.
For decades, inflation has been regarded as “the overriding economic enemy”, says Jeremy Warner in The Daily Telegraph. But “in an age of explosive public debt” governments will start to see it as more friend than foe. When the economy finally re-awakens conditions could very quickly turn inflationary, and “almost inevitably, the central bank will be looking in the wrong direction”.
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