Robert J. Samuelson: Rising global debt a real danger

Six years after the onset of the financial crisis, the world still has too much debt. The total in 2013, according to the McKinsey Global Institute, came to about $186 trillion. This includes government debt, corporate bonds and loans to individuals, families and businesses. Since 2008, the amount has actually increased by about $34 trillion. The numbers are so large that it’s hard for ordinary mortals to connect them with the world economy’s ability to grow at a decent and self-sustained pace. Doubts about this underlie the stock market’s recent turmoil.

Let it be said that, as with most major market moves, we usually know only in retrospect whether they reflected basic economic realities or just a shift in crowd psychology (Ebola?). “Global outlook [is] nowhere near as bad as markets suggest,” Capital Economics, a forecasting firm, wrote clients. This is possible.

If the market’s wild swings transcend mood, the explanation may involve the potentially dangerous interaction between high debt and low economic growth. To service their debts, borrowers – governments as well as companies and individuals – need rising incomes, whether from taxes, profits or salaries. If incomes stagnate or decline, paying debts’ interest or principal becomes harder.

Worse, borrowers and lenders may get caught in a self-destructive, vicious cycle that ends with deflation (falling prices). To make loan repayments, borrowers curb spending. But spending is the lifeblood of modern economies, so if too many governments, people or firms cut back, the economy doesn’t generate the incomes that the debtors need to meet their loan commitments. What’s logical for a few debtors becomes catastrophic if everyone does it. There’s a debt trap that threatens growth.

By itself, the slowdown in global economic growth, predicted by the International Monetary Fund and others, is fairly mild. It’s undesirable but not disastrous. What would make it disastrous is if it triggers a broader and deeper economic pullback: a new recession or financial crisis – involving defaults, bankruptcies and panics. The consequences could be devastating, because the world hasn’t yet recovered from the 2008-09 crisis. Any deflation would increase debt burdens by forcing borrowers to repay with costlier money.

A new report from four economists echoes these fears. First, they note that worldwide debt – again, governmental and private – has continued to grow. Since 2008, it has increased from 174 percent of global gross domestic product to 212 percent. The biggest increases occurred among “emerging market” countries, led by China. Its debt soared by 72 percentage points to 217 percent of GDP in 2013. In 2013, similar debt/GDP percentages were 264 for the United States, 257 for the eurozone (the 18 countries using the euro) and 411 for Japan.

As these figures suggest, there’s no “right” or “wrong” amount of debt. The correct amount depends on how fast a country’s economy is growing, the level of interest rates, how well the debt is invested and – a crucial factor – lenders’ faith that they will be repaid. If confidence vanishes, trouble looms.

Called the Geneva Report, the study warns against the “poisonous combination” of high debt and low economic growth. It says that emerging-market countries “could be at the epicenter of the next crisis.” Presumably, this would mean losses on public and private bonds and loans. The study also says the eurozone is vulnerable. (The study’s authors: Vincent Reinhart of Morgan Stanley, Lucrezia Reichlin of the London Business School, Philip Lane of Trinity College Dublin and Luigi Buttiglione of Brevan Howard Investment Products.)

It’s not clear how weak the global economy is. There are (relative) bright spots. Both the United States and Great Britain have achieved moderate growth, in part because their households have “deleveraged” – that is, cut debt. From 2007 to 2013, U.S. households reduced mortgage debt by $1.2 trillion through repayment and default, says the Geneva Report. Businesses have done something similar: They’ve refinanced old debt at lower interest rates and longer maturities. For households and firms, lower debt burdens free up more cash for present spending.

The roughly 25 percent decline in oil prices since June – most of which will be passed along to drivers at the pump – is another possible positive. Assuming the cuts hold, gasoline prices could drop to close to $3 a gallon, with annual U.S. consumer savings approaching $100 billion, says oil analyst Larry Goldstein. (However, Goldstein warns that falling prices may signal a faltering economy.)

Can we avoid a global debt trap and regain faster economic growth rates that foster stability and human well-being? Whatever debt’s virtues as a first response to deep slumps, it has its limits. We cannot promote prosperity simply by piling new debts atop the old. We need to build a stronger economic foundation.