Following the financial crisis of 2008, a widely held belief is that the global economy is on a path to deleverage. This theory was quashed by the 16th Geneva Report on the World Economy, which found the ratio of global total debt (excluding financial institutions) over GDP has in fact increased by 38 percent since 2008, currently standing at 212 percent. The combination of escalating debt with slow GDP growth is “poisonous”, the report warns. If significant preventative action is not taken soon – by the governments of both struggling and thriving nations – the second global financial crisis of the 21st century could be just around the corner.
Although the developed economies that previously suffered have, for the most part, recovered well, it is now, rather ironically, the emerging markets who were the drivers of that recovery that could be at the centre of the next crisis. Although debt is a necessary component of stimulating economic growth – money is created through the accrued interest on debt, after all – emerging markets’ borrowing has spiralled out of control and must be curbed so as to not risk the world falling into another global financial crisis.
A lending binge in the first half of 2014 caused emerging market countries’ borrowing to rocket to an all-time high, putting a strain on global economic growth. International sovereign bond sales by emerging markets reached a record $64.47bn in the first six months of this year – 54 percent higher than the same period last year. At present, the global economy is somewhat propped up by the US where growth continues to rise, further driven by the recent announcement that unemployment has dropped to 5.9 percent – the lowest recorded figure since July 2008. This fuelled a renewed confidence in the market and a surge in dollar value. However, Federal Reserve movements continue to have a direct influence on emerging market debt performance, and a booming US dollar and low interest rates only increase the debt owed by these nations. “Currency wars” could be a headline we see all too soon.
It is now, rather ironically, the emerging markets who were the drivers of recovery that could be at the centre of the next crisis
While borrowing in developed markets propelled global leverage up to the last crisis, the tables have now turned and emerging markets, most notably China, have been the driving force behind the leverage process. “Although the level of leverage is higher in developed markets, the speed of the recent leverage process in emerging markets, and especially in Asia, is indeed an increasing concern,” according to the report. Increasingly volatile interest rates in these nations further contribute to the problem.
William Jackson, Senior Emerging Markets Analyst at Capital Economics, says that this is different from the financial woes seen in emerging markets in the 1980s and 1990s, though. “The real problem in emerging markets in the past was that credit lending took place in foreign currencies. This meant that when there was a problem, and currencies fell, there was a vicious cycle. With local currency now being the main form of lending, potential foreign currency problems wouldn’t be as big an issue as they once were.”
Although the report focuses on China, further concerns are raised about the ‘fragile eight’: Argentina, Brazil, Chile, India, Indonesia, Russia, South Africa and Turkey, nations in which leverage continues to rise. The report’s fixation on China is not unfounded, by any means – since 2008, Chinese total debt (excluding financials) is up by a massive 72 percent of GDP, 14 percent per year. To put that into perspective, that’s double the rate of growth seen in the UK and US in the lead-up to the crisis of 2008. Chinese productivity growth is now at approximately 50 percent of what it was in 2006, as the working-age population begins to dwindle. Additionally, geopolitical issues – for example, the ongoing conflict between Russia and Ukraine – have a profoundly negative impact on economic activity in these nations, as uncertainty of any kind dampens market confidence.
Despite efforts by the central banks of developed economies to promote inflation, little progress has been made. If interest rates are not kept low enough and for long enough, the global economy is at risk of crumbling under the pressure of mounting debt. The predicament is that, while low interest rates are crucial in order for the economy to recover, it is the bubble created by those low interest rates that caused the world to sink into such debt in the first place: such is the vicious cycle the global economy finds itself in.
Governments must take necessary measures to support growth and prevent deflation, all the while maintaining reasonable rates of interest. Additionally, the introduction of bolder policies would inject new momentum and stimulate growth. This is a job they simply cannot manage alone – responsibility also lies with the governments and central banks of developed economies. Cooperation, rather than competition, is required. However, if emerging markets do not begin to pull their weight and begin contributing to global economic growth rather than stifling it, it could be inconceivably damaging to the global economy.
