Opinion: Opinion: High debt and stagflation will bring the mother of all financial crises

NEW YORK (Project Syndicate)—The global economy is poised for an unprecedented confluence of economic, financial and debt crises, due to the explosion of deficits, loans and leverage over the past several decades.

In the private sector, the mountain of debt includes that of households (such as mortgages, credit cards, car loans, student loans, personal loans), businesses and corporations (bank loans, bond debt and private debt), and the financial sector (liabilities of banking and non-banking institutions).

In the public sector, it includes central, state, and local government bonds and other formal liabilities, as well as implicit debts such as unfunded liabilities from pay-as-you-go pension and healthcare systems, all of which will continue to grow as societies age.

Staggering debt burdens

Looking at explicit debt alone, the numbers are staggering. Globally, total private and public sector debt as a percentage of gross domestic product has increased from 200% in 1999 to 350% in 2021. The ratio is now 420% in advanced economies and 330% in China.

In the United States it is 420%, which is higher than during the Great Depression and after World War II.

Of course, debt can stimulate economic activity if borrowers invest in new capital (machinery, homes, public infrastructure) that yields a higher return than the cost of borrowing. But borrowing heavily is simply used to finance consumer spending that exceeds one’s income, and that is a recipe for bankruptcy.

In addition, investments in “capital” can also be risky, whether the borrower is a household buying a house at an artificially high price, a company looking to expand too quickly regardless of returns, or a government spending the money on “white elephants”. “. (extravagant but useless infrastructure projects).


Such overlending has been going on for decades, for a variety of reasons. The democratization of the financial world has enabled income-deprived households to finance consumption with debt. Center-right governments have consistently cut taxes without also cutting spending, while center-left governments have spent generously on social programs that are not fully funded with sufficiently higher taxes.

And debt-over-equity tax policies, supported by central banks’ ultra-loose monetary and credit policies, have caused a spike in borrowing in both the private and public sectors.

Years of quantitative easing (QE) and credit easing kept borrowing costs around zero TMUBMUSD10Y,
and in some cases even negatively (as, until recently, in Europe and Japan). By 2020, dollar-equivalent government debt with a negative yield was $17 trillion, and in some Scandinavian countries even mortgages had negative nominal interest rates.

Insolvent zombies

The explosion of unsustainable debt ratios implied that many borrowers – households, companies, banks, shadow banks, governments and even entire countries – were insolvent “zombies” backed by low interest rates (which kept their debt management costs manageable). ).

During both the 2008 global financial crisis and the COVID-19 crisis, many insolvent agents who would have gone bankrupt were bailed out by zero or negative interest rate policies, QE and outright fiscal bailouts.

But now inflation – fueled by the same ultra-loose fiscal, monetary and credit policies – has put an end to this financial dawn of the dead. With central banks forced to raise interest rates FF00,

in an effort to restore price stability, zombies are experiencing sharp increases in their debt service costs.

For many, this represents a triple whammy, as inflation also erodes real household income and reduces the value of household assets, such as homes and stocks.
The same applies to fragile and overburdened companies, financial institutions and governments: they are simultaneously confronted with sharply rising borrowing costs, declining revenues and earnings, and declining asset values.

The worst of both worlds

Even worse, these developments coincide with the return of stagflation (high inflation alongside weak growth). The last time developed economies experienced such conditions was in the 1970s. But back then debt ratios were very low anyway. Today we are facing the worst aspects of the 1970s (stagflationary shocks) alongside the worst aspects of the global financial crisis. And this time, we can’t just cut interest rates to stimulate demand.

After all, the global economy is plagued by persistent negative supply shocks in the short and medium term, which curb growth and raise prices and production costs.

These include the pandemic’s disruptions to the supply of labor and goods; the impact of the Russian war in Ukraine on commodity prices; China’s increasingly disastrous zero-COVID policy; and a dozen other medium-term shocks – from climate change to geopolitical developments – that will add additional stagflationary pressures.

Unlike the 2008 financial crisis and the early months of COVID-19, simply bailing out private and public agents with loose macro policies would add more fuel to the inflationary fire. That means there will be a hard landing – a deep, prolonged recession – on top of a severe financial crisis. As asset bubbles burst, debt service ratios rise and inflation-adjusted incomes fall among households, businesses and governments, the economic crisis and the financial crash will feed off each other.

Of course, advanced economies borrowing in their native currencies can use a bout of unexpected inflation to lower the real value of some fixed-rate long-term nominal debt. With governments unwilling to raise taxes or cut spending to reduce their deficits, central bank monetization of deficits will again be seen as the path of least resistance.

But you can’t fool all the people all the time. Once the inflationary genie comes out of the bottle – which will happen if central banks give up in the face of the looming economic and financial crash – nominal and real borrowing costs will rise. The mother of all stagflation debt crises can be postponed, not avoided.

Nouriel Roubini, professor emeritus of economics at New York University’s Stern School of Business, is the author of “MegaThreats: Ten Dangerous Trends That Imperil Our Future, and How to Survive Them” (Little, Brown and Company, 2022).

This commentary is published with permission from Project Syndicate — The Unavoidable Crash

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