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The Global Debt Threat Is Reigniting -- Barron's

19 May 2018 10:00 am
By Michael Heise 

Global growth is accelerating. But before we break out the Champagne, we should acknowledge the long-term risks to sustained expansion posed by rising private and public debt.

Market analysts view the uptick in private lending in most emerging and some developed economies as a sign of higher demand and a precursor to faster growth. But, while this is true in the short run, the relentless rise of debt remains among the most serious problems burdening the global economy.

Despite years of deleveraging after the 2008 global financial crisis, debt still is high, and now we have returned to an expansionary credit cycle. According to the Bank for International Settlements, total nonfinancial private and public debt amounts to almost 245% of global gross domestic product, up from 210% before the financial crisis and about 190% at the end of 2001.

General government borrowing in the U.S. might reach 5% of GDP this year, pushing total public debt to about 108% of GDP. In the euro zone, public debt totals about 85% of GDP; in Japan, the debt-to-GDP ratio is close to an eye-popping 240%. Globally, private nonfinancial debt is growing faster than nominal GDP.

These trends are set to continue, as many major central banks, including the European Central Bank and the Bank of Japan, not only have welcomed the recovery in lending, but also are aiming to stimulate more credit-financed growth. Only the U.S. Federal Reserve and the People's Bank of China are taking steps to rein in bank lending.

The world has endured enough economic crises to know that high debts create serious risks. Nominal debt is fixed, but asset prices can collapse, generating huge balance-sheet losses and causing risk premiums -- and thus borrowing costs -- to rise. A decade ago, when a credit-fueled financial boom turned to bust, the financial sector was pushed to the brink of collapse, and a yearslong recession followed.

The only sustainable debt burden is one that can be managed even during cyclical downturns. Yet governments continue to treat debt as a boon for long-term growth, rather than what it is: a heavy burden and source of massive long-term risks.

It is time for policy makers and their economic advisers to recognize this and abandon the assumption that more debt always leads to more growth. Although there are times when governments need to borrow to stimulate the economy, deficit spending can't lift growth in the long term. And at times like now, when growth rates and private-sector borrowing are rising, governments should be working to reduce their deficits. This is relevant for the U.S. and Japan, and for European Union countries, which should take advantage of today's recovery to bring their public finances in line with the Stability and Growth Pact.

Governments should seek to stimulate long-term, non-debt-financed growth using a combination of regulation, trade agreements, investment incentives, and educational and labor-market reforms. In a low-inflation environment like today's, central banks can cushion the impact of such reforms through expansionary monetary policies.

But central banks must calibrate their interventions carefully to ensure that monetary expansion doesn't encourage the buildup of even more private-sector leverage. This means thinking twice before enforcing negative deposit rates, designed to pressure banks to lend more, or liquidity operations conditioned on bank lending. A better approach would emphasize the use of forward guidance to influence interest-rate expectations and bond yields. Low yields can fuel asset-price increases and stimulate demand in a range of areas, not only through higher corporate leverage.

That said, with asset prices already high and economies growing nicely, central banks should follow the Fed's lead in gradually unwinding the stimulus programs initiated after the 2008 crisis. Moreover, regulators should do more to ensure that private debt is channeled toward productive uses. This is the lesson from previous debt crises, including the subprime-mortgage bubble that triggered the meltdown a decade ago.

Regulatory authorities can employ macroprudential policies to impose limits on segments of financial markets that are overheating, thereby improving the allocation of capital and stabilizing investment returns. They should take particular care to prevent real estate bubbles, because real estate constitutes a huge share of wealth and a key source of collateral in finance. The rise of low-quality leveraged loans should also be a concern.

None of this will be easy. Preventing the growth of bubbles is notoriously difficult, and the types of structural reforms needed to secure a shift away from debt-fueled growth are hardly ever popular. Today's febrile political environment won't simplify matters. But the consequences of shying away from such choices could be devastating. The financial cycle will continue to gain momentum, eventually causing asset prices to overshoot fundamentals by a wide margin; leverage ratios will rise even further, and demand will outstrip capacity, spurring inflation.

At that point, an external shock or a decision by central banks to apply the monetary brakes will lead to a potentially ruinous crash. Financial markets would take a major hit. Private leverage and public debt levels would suddenly look a lot less sustainable.

Times may be good, but good times are when risks build up. Policy makers can't say they haven't been warned. --

Michael Heise is chief economist of Allianz and the author of Emerging From the Euro Debt Crisis: Making the Single Currency Work.

Copyright: Project Syndicate, 2018
 

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May 19, 2018 06:00 ET (10:00 GMT)

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