IMF Fears That the Global Debt Boom Could Lead to a Stock Market Crash and Cripple the Economy
The world has been facing an extremely powerful microscopic enemy for a year now. The COVID-19 pandemic has hit every country in the world hard. A great economic crisis has gripped most of the major economic powers in 2020.
In the face of this economic crisis, most of the major powers have followed the example of the United States.
Aggressive monetary policy and debt to finance massive plans to support the economy. More than 12,000 billion dollars have been printed out of thin air in a few months. The Fed has printed more than 4,000 billion dollars in a few months.
Thus, more than 20% of the American dollars in circulation today were issued in the last year. This is simply colossal!
The world debt has become parabolic to reach $277T at the end of 2020
At the same time, the US public debt has obviously soared. This strategy of systematic recourse to debt has pushed the world debt to $277T at the end of 2020 according to the Institute of International Finance (IIF). For the IIF, the most worrying thing is to see that the trend was already towards a massive acceleration in global debt well before the COVID-19 pandemic:
“The pace of global debt accumulation has been unprecedented since 2016.”
The world debt has become parabolic and now represents 365% of the world GDP.
From 2016 to 2020, the world’s debt increased by $56 trillion. This is ten times more than the increase observed by the IIF from 2012 to 2016. When I talk about the global debt that has become parabolic, you can see that this only reflects the reality of the numbers.
The IIF does not mince words when it talks about the “tsunami of debt”. This is indeed the reality of the world in 2020, but it is always more impressive when an institution like the IIF says it in such a brutal way.
In this year 2020, we’ve gone from billions of dollars to trillions of dollars. This is proof that the magnitude of the problems continues to grow. In fact, many people find all these numbers abstract. You get used to these numbers by hearing them and you don’t worry about them anymore.
This rapid increase in global debt has everyone concerned, starting with the IMF
As you can easily imagine, such a level of debt is worrying. Even more worrying is the rate of increase of the debt at the global level.
Adolfo Barajas and Fabio Natalucci, economists at the International Monetary Fund (IMF), have just published a blog post that aims to alert us to the situation of the world economy.
For them, the massive recourse to debt constitutes “a double-edged sword” for financial stability. Policymakers are therefore clearly faced with “a dilemma”. On the one hand, the IMF stresses the positive side of the use of debt during the COVID-19 pandemic.
The leverage that goes with it played “a particularly important role” in the recovery as government support and accommodative monetary policies by central banks ensured that firms and households continued to access the credit market.
“Many firms managed to limit the number of workers they had to lay off” through this process. When a company takes on debt to increase its investment capacity and profitability, it is called leverage.
The higher the debt in relation to the cash generated by the company, the higher the leverage. But the greater the leverage, the greater the risk to the company in the event of a downturn in its business.
IMF warns of major risk to global financial stability
This is where a major risk lies for the IMF:
“However, high levels or rapid increases in leverage can represent a financial vulnerability, leaving the economy more exposed to a future severe downturn in activity or a sharp correction in asset prices.”
While the IMF recognizes that the massive recourse to debt was necessary to protect the global economy in the short term, it warns of the “devastating impact” that this could have on financial stability in the years to come:
“Such an increase of global debt may be a vulnerability that poses a risk to financial stability further down the road.”
To support their statements, these two IMF economists point out that financial crises have “often” been preceded by rapid increases in debt, frequently referred to as “credit booms”.
Moreover, they note that before the COVID-19 pandemic, the indebtedness of the non-financial private sector (households and non-financial companies) was already “steadily increasing”.
IMF now calls for a change in central bank strategy
To get out of the dilemma policymakers are currently facing, the IMF recommends setting borrowing limits.
A study published by the IMF, and cited in the two economists’ blog post, “shows that, after countries tighten borrower-related tools (e.g., reducing the maximum loan-to-value ratio for mortgage borrowers), leverage for households slows.”
They then add:
“When policymakers tighten liquidity regulations on banks (e.g., raising the minimum amount of liquid assets that must be held in proportion to total assets), leverage of firms slows in response. And when policymakers in emerging markets tighten foreign currency constraints on banks (e.g., limiting their open foreign currency positions), leverage of firms slows down as well.”
It seems that the Fed has already opted for this strategic option. On March 19, Jerome Powell announced that the tool put in place last year by the Fed at the beginning of the economic crisis to facilitate credit to households and businesses would expire on March 31.
Of course, we will have to watch what other central banks around the world do.
In any case, the risk of a stock market crash remains more than ever in the months to come. While the COVID-19 pandemic seems to be under control during this year thanks to the massive vaccination campaigns conducted all over the world, it seems that a new enemy is threatening us.
Macroscopic, this enemy is the global debt. It may prove even more difficult to defeat than the COVID-19 pandemic.