Global debt has reached around $313 trillion or 330 percent of world GDP, up from around $210 trillion a decade ago. Around half the rise is in developed economies, such as the US, Germany and France. Emerging markets, such as China, India, Russia, Argentina, Malaysia and South Africa, have also registered large increases. Since 2000, China’s total debt has nearly tripled to around 288 percent of GDP.
Public borrowings, particularly in developed economies, have grown. As a percentage of total output, government debt in Japan, the US and the UK has reached 252 percent, 127 percent and 106 percent, representing increases of 116 percent, 71 percent and 69 percent between 2000 and 2024.
The drivers include increased reliance on debt-funded economic activity as well as the aftermath of the 2008 global financial crisis, and the pandemic. The world’s current level of borrowings are highly problematic.
Debt can be useful in matching needs and available funds over time. Loans used to finance expenditures that generate adequate cash flows to ultimately repay the loan with market interest rates are sustainable. But instead, much new debt has been directed to potentially unproductive uses.
Household and personal debt has financed housing and consumption. Borrowers have taken out increasingly large mortgages, reliant on the collateral value of property that is arguably overpriced as a result of nearly two decades of abnormally low interest rates and manipulation of supply. Households equate borrowings to income to support their spending because of stagnant incomes, reflecting the reduced share of GDP accruing to labour relative to businesses and inflation pushing up the cost of goods and services.
Instead of investing in infrastructure and other strategic areas, governments have borrowed to finance recurrent expenditure, transfers, tax cuts and replace lost earnings during the lockdown. Governments are now spending on wars and defence due to deteriorating global security and extreme weather events. There is no sign of this spending abating. The US has spent about $10 trillion since the pandemic and current government spending is running about $2 trillion above long-term annual levels.
Even where borrowing has financed infrastructure such as in China, the spending has often been misdirected. It has created over-capacity in certain industries, which has affected the economics of projects. Some investments are unlikely to be useful for some time, by which time the facilities may be outdated or in disrepair.
Rather than improving or expanding production or funding research and development, corporations have frequently used debt for financial engineering—repurchasing their own shares to inflate earnings or for mergers and acquisitions.
Economist Hyman Minsky distinguished between hedge finance (current cash flow covers principal and interest), speculative finance (cash flow covers interest but not principal) and Ponzi finance (cash flow does not cover principal or interest). Today, debt-financed speculation with exaggerated reliance on asset price rises to meet future obligations has reached the final stage.
High levels of indebtedness have several consequences. They limit economic flexibility with normalised rates, raising interest payments. Borrowing costs on government debt alone reached $2 trillion at the end of 2023 and is expected to rise to over $3 trillion by 2028.
Rising debt levels also reduce the capacity to deal with unexpected events, such as the pandemic and natural disasters. Declines in the value of government debt could destabilise holders like financial institutions and central banks. Ongoing fiscal deterioration and currency debasement risk loss of confidence amongst foreign investors in sovereign debt.
There are also limited options for managing these high levels. They can only be amortised from growing income or reduced by inflation. Moribund growth will not reduce debt levels significantly, given economic activity is credit driven. Over time, more borrowing with diminishing returns is needed simply to maintain status quo.
Borrowers could divert income to pay off debt, which is problematic where it has financed projects that generate insufficient cash flow. Households would require large wage increases or have to curtail consumption. Governments would need to rein in deficits by imposing higher taxes and/or cutting spending. Any such sharp deleveraging risks setting off a recessionary spiral, making repayment even more difficult.
Inflation, effectively covert taxation, can help reduce debt by boosting revenues and reducing purchasing power but would hurt low income groups, exacerbate inequality and raise social tensions. Currency devaluations would reduce the value of outstanding debt held by foreigners but affect import costs or the ability to borrow overseas.
The historical experience is salutary. Between 1914 and 1939, World War I and the Great Depression damaged public finances. Countries making up nearly half of global output defaulted or were forced to enter arrangements with creditors. After World War II, some countries defaulted or experienced hyperinflation. Others resorted to capital controls, loan rationing and financial repression with mandatory investment in government debt at below inflation rates. Only strong growth driven by pent-up demand and post-war reconstruction helped bring down borrowing levels. Substantial debt reduction today will be highly challenging.
The risk is of debt deflation. The overhang of borrowings may lead to a collapse in consumption which, in turn, sets off reductions in investment due to a lack of demand. Businesses and consumers who have borrowed money may struggle to service commitments with some failing. Financial sector instability would result as highly leveraged banks have their earnings and capital bases eroded by bad loans. Simultaneous falls in government revenues would restrict their ability to reflate the economy because of the constraints posed by high debt levels. The resulting deflation would make existing borrowings even more difficult to service.
Buoyant stock markets and real estate today reflect unsustainable monetary expansion. But true prosperity cannot be built on excessive cheap debt. Periods of rapid growth in borrowings inevitably result in unsound investments, which are eventually exposed when the credit expansion stops, reverses or significantly slows down.
Over the last quarter of a century, the world has perversely tried to solve the problems of debt with more borrowing. While fancy financial engineering can forestall the end, it cannot prevent the inevitable.
Satyajit Das
Former banker and author
(Views are personal)