Is Another Debt Crisis On the Way?
Dec 18, 2017 | KEMAL DERVIŞ
WASHINGTON, DC – Economic growth is accelerating across most of the world. Yet
the world’s total gross debt-to-GDP ratio has reached nearly 250%, up from 210%
before the global economic crisis nearly a decade ago, despite post-crisis efforts by
regulators in many important economies to drive the banking sector to deleverage.
This has raised doubts about the sustainability of the recovery, with some arguing
that a rise in interest rates could trigger another global crisis. But how likely is that
To answer this question, one must recall that debt is both a liability and an asset. In a
closed economy – and we don’t owe anything to non-Earthlings – overall debt and
the corresponding assets necessarily cancel each other out. So what really matters is
the composition of debts and liabilities – or, to put it simply, who owes what to
High public-sector debt, for example, signals the possible need for tax increases – the
opposite of the tax legislation being advanced by Republican legislators in the United
States – and/or higher interest rates (real or nominal, depending on monetary policy
and inflation). If debt is owed largely to foreign lenders, interest-rate risk is
compounded by exchange-rate risk.
For private-sector debt, much depends on its type: the hedging sort, where a debtor’s
cash flow covers all obligations; the speculative type, where cash flow covers interest
only; or the Ponzi kind, where cash flow does not even cover that. As the late
American economist Hyman Minsky explained, the higher the share of debt that falls
into the speculative or Ponzi categories, the higher the risk that a confidence shock
will trigger a sudden wave of deleveraging that quickly morphs into a full-blown
For both public- and private-sector debt, maturities also play an important role.
Longer maturities leave more time for adjustment, lowering the risk of a confidence
Yet while it makes little sense to focus on simple aggregate figures, both public
institutions and private researchers tend to do precisely that. Consider the coverage
of the Greek debt crisis. Headlines tracked the debt-to-GDP ratio’s climb from 100%
in 2007 to 180% this year, yet little attention was paid to private-sector debt. And, in
fact, as foreign public creditors replaced private debt holders and interest rates were
lowered, Greece’s overall debt, while still high, became more sustainable. Its
continued sustainability will depend partly on the trajectory of Greece’s GDP – the
denominator in the debt ratio.
A similar mistake is made in assessing China’s debts, about which the world is most
concerned. The figures are certainly daunting: China’s debt-to-GDP ratio now stands
at about 250%, with private-sector debt amounting to about 210% of GDP. But about
two-thirds of the private-sector debt that is defined as bank loans and corporate
bonds is actually held by state-owned enterprises and local-government entities. The
central government has considerable control over both.
For China, the biggest risk probably lies in the shadow banking sector, on which
reliable data are not available. On the other hand, a significant share of the growth
in private debt ratios in recent years may be a result of the “formalization” of parts
of the shadow banking system – a trend that would bode well for economic stability.
And there is more good news for China. Most Chinese debt is held in renminbi; the
country possesses massive foreign-exchange reserves of close to $3 trillion; and
capital controls are still effective, despite having been eased in recent years. The
country’s leaders thus have a public-policy war chest that they can use to cushion
against financial turmoil.
Among the rest of the emerging economies, there are some sources of concern. But,
overall, the situation is relatively stable. Though private-sector debt has lately been
rising, its levels remain tolerable. And public-sector debt has been growing only
moderately, relative to GDP.
As for the advanced economies, there is little reason to believe that a debt crisis is
around the corner in Japan. In the US, public debt is set to increase, thanks to the
impending tax overhaul; but the blow will be cushioned, at least for the next year or
two, by continued growth acceleration. And though low-quality assets held by the
banking system are likely to impede Europe’s recovery, they are unlikely to spark a
In short, the world does not seem to face much risk of a debt crisis in the short term.
On the contrary, the stage seems to be set for continued increases in asset valuations
and demand-driven growth.
That said, geopolitical risks should not be discounted. While markets tend to shrug
off localized political crises and even larger geopolitical challenges, some dramas
may be set to spin out of control. In particular, the North Korean nuclear threat
remains acute, with the possibility of a sudden escalation raising the risk of conflict
between the US and China.
The Middle East remains another source of serious instability, with tensions in the
Gulf having intensified to the point that hostilities between Iran and Saudi Arabia
and/or turmoil within Saudi Arabia are not unthinkable. In this case, it is Russia that
might end up clashing with the US.
Even barring such a major geopolitical upheaval, which would severely damage the
global economy’s prospects in the short run, serious medium- and long-term risks
loom. Rising income inequality, exacerbated by the mismatch between skills and jobs
in the digital age, will impede growth, unless a wide array of difficult structural
reforms are implemented, including reforms aimed at constraining climate change.
As long as the geopolitical situation remains manageable, policymakers should have
time to implement the needed structural reforms. But the window of opportunity
will not stay open forever. If policymakers waste time on trickle-down sophistry, as is
happening in the US, the world may be headed for severe economic distress.
Writing for PS since 2003
Kemal Derviş, former Minister of Economic Affairs of Turkey and former Administrator for the United
Nations Development Program (UNDP), is Senior Fellow at the Brookings Institution.
Is Another Debt Crisis On the Way?