Economists are starting to worry about the sustainability of high levels of debt as global interest rates rise sharply. A credit crunch could fuel “the mother of all economic crises,” Nouriel Roubini warned last week. Some experts have compared the current situation to the structural issues that triggered the 2008 financial crash. Loading Something is loading.
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As global interest rates rise at a staggering pace, economists are starting to worry about the mountain of debt built up over the years when borrowing costs languished near zero.
Nouriel Roubini raised the alarm last week, warning that the steep rise in rates could erode the ability of households and companies to meet their loan repayment commitments. He said that could trigger “the mother of all economic crises”.
Roubini echoed organizations like the International Monetary Fund and the World Bank, whose chiefs have warned that the rising debt burden puts the global economy at risk of slipping into a severe recession.
Concerns have grown as to whether the high levels of debt in the US economy are sustainable, after the Federal Reserve boosted its benchmark rate to 4%, from a range between zero and 0.25% as recently as March. Other central banks across the world also have lifted rates sharply to combat soaring prices.
Here’s why economists have started fretting about the risk of a debt crunch — and why such an eventuality could lead to a stock market crash.
Why has global debt risen?In the aftermath of the 2008 global financial crisis, central banks flooded markets with cheap money by slashing interest rates to record lows and using a policy known as quantitative easing (QE) to buy trillions of dollars in financial assets.
The fall in borrowing costs made it easier for companies, governments, and ordinary Americans to take out loans, and fueled the rise of what Roubini calls “zombies” – people and businesses propped up by cheap debt rather than sound financials.
And as interest rates have rebounded sharply this year, it’s getting harder for those borrowers to repay their loans.
What’s happening with interest rates?The Fed is raising interest rates in a bid to tame inflation, which is running close to forty-year highs.
That monetary-tightening campaign is aimed at bringing down consumer spending, which would help to curb price rises.
But it also raises the cost of borrowing — making it more expensive for individuals to take out a loan to buy a house, for companies to invest in their business and for governments to spend on education or healthcare.
It also makes it harder for debt-laden zombies to secure financing.
What could happen next?Roubini has warned that a combination of mounting debt, high inflation and low growth will trigger a global economic crash — and that stocks could fall another 25%.
Central banks like the Fed won’t be able to prevent an economic downturn, because consumer prices would increase faster if policy makers eased up on tightening, he said.
“The mother of all stagflationary debt crises can be postponed, not avoided,” Roubini wrote in a Project Syndicate op-ed last week.
The IMF and the World Bank have linked the runup in debt to heightened instability, with the threat of a crisis potentially injecting further volatility into markets next year.
How would that compare to 2008?It’s natural for economists to draw comparisons between the current situation and the last major financial crisis.
In 2008, cheap credit and lenient lending standards helped to fuel a housing bubble — and when that popped, prices plummeted and exposed banks went bust.
Roubini has drawn comparisons between the build-up in debt that’s causing economists to fret right now and that Global Financial Crisis, when stock markets rapidly lost around half their value.
So while war in Ukraine, rising interest rates, and a looming recession are the stories dominating markets, a potential debt crisis could quickly rocket up investors’ long list of concerns for 2023.