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Tears for arrears

5 February 2015 By Peter Thal Larsen

So much for deleveraging. Despite near-universal promises to reduce borrowing, global debt has escalated since the financial crisis. Governments, households, companies and banks owe $53 trillion more than they did at the end of 2007, according to a new report by the McKinsey Global Institute. The swelling demands more radical surgery.

It’s no secret that wider government deficits and low interest rates have led to extra borrowing in a sluggish global economy. Even so, the rate of expansion is startling. Total debt was 286 percent of global output by mid-2014, up 17 percentage points from the end of 2007. Over that period, government liabilities increased at a compound annual rate of 9.3 percent, far exceeding economic growth. Corporate debt rose by 5.9 percent a year. In China, total borrowing quadrupled to $28.2 trillion.

The debt bulge increases the risk of future crises. Though banks have more equity and have stopped expanding their balance sheets, bond markets and other forms of non-bank lending have more than filled the gap. Moreover, there is little prospect of countries growing their way back to prudence. Only five relatively small economies saw total debt fall as a proportion of GDP over the past seven years. Slow growth and falling inflation means the burden will keep expanding.

The diagnosis calls for more drastic measures than have been considered so far. One idea is to make debt contracts more flexible, so that lenders share in the pain if the value of the underlying collateral falls. Another is to end the favourable tax treatment of interest. But these measures will not lower accumulated debt. Tackling the backlog requires default, or some form of forgiveness. This can be messy, as the Greek government’s battle with the euro zone authorities illustrates.

But any analysis of debt must also factor in the identity of the lenders – after all, the sum of global assets and liabilities remains zero. Much of the increase in sovereign debt since 2007 is in the hands of central banks from the same country. Cancelling those loans by permanently turning them into money may be the only way to reverse the swelling.


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