As the coronavirus pandemic spreads violently across the globe, threatening to unleash a humanitarian catastrophe in its wake, the world suddenly finds itself in the midst of an unprecedented economic experiment: what happens when you force a virtual shutdown of productive and commercial activity in a global economy already blighted by years of anaemic growth and record levels of indebtedness?
According to the Institute of International Finance, total debt reached $253 trillion in late 2019, or the equivalent of 322% of global GDP – the highest it has ever been. Now that large parts of Europe and North America are following China in imposing far-reaching lockdowns, concerns are growing over the viability of this enormous debt pile. In the sharp economic contraction of the next few months, widely expected to become the worst in peacetime history, countless borrowers will struggle to repay their debts. This in turn risks unleashing a major international debt crisis that will make the market crash and global recession of 2008–’09 look like child’s play.
To be clear: these systemic vulnerabilities precede the present pandemic and have been well over a decade in the making. For years now, experts have been issuing repeated warnings of surging global debt levels – with many noting that even a relatively mild shock, like a continued rise in interest rates, could easily tip the world into a fresh financial crisis. As recently as January, the incoming chief of the International Monetary Fund, Kristalina Georgieva, shared her concern that renewed market instability might well leave the global economy susceptible to a repeat of the Great Depression.
At that point, few people could have foreseen the sheer scope and intensity of the public health emergency that still lay ahead. Unlike the new strain of coronavirus that triggered this medical crisis, however, the mountains of debt that now threaten to sink the global economy are no force of nature: they are man-made, and largely a consequence of the particular ways in which policymakers chose to deal with the last financial crisis.
As we all know, governments around the world responded to the crash of 2008 by bailing out their financial institutions, leading to a rapid rise in public debt levels, especially in Europe, where the resultant loss of investor confidence subsequently triggered the European sovereign debt crisis, which was never truly resolved. This second stage of the global financial crisis marked the beginning of a decade of austerity, with many governments aggressively cutting back on social spending – including in the healthcare sector – while doing everything in their power to prop up the global financial system.
The world’s leading central banks soon joined this effort to preserve the financialised world economy, cutting interest rates to historic lows and pumping the equivalent of over $11 trillion worth of new money into circulation through their quantitative easing (QE) programmes. These dramatic monetary interventions helped stave off a total collapse of the global financial system, but they came at the cost of a fresh wave of speculative investment and a rapid increase in global debt levels, which has left the world economy extremely vulnerable to an unforeseen external shock.
And what a shock we got: a near-complete shutdown of productive and commercial activity in some of the world’s leading economies, combined with a collapse in the oil price followed by a synchronised and virtually instantaneous crash of money and capital markets, which threatened to freeze up international credit and payments systems, amidst concerns over collapsing global supply chains and skyrocketing unemployment levels. If ever there was a perfect storm, this has to be it.
As financial markets went into meltdown over the past two weeks, the leading central banks once again intervened aggressively, dropping interest rates back to their historic lows and announcing the extension of US Federal Reserve swap lines and gargantuan new QE bond-buying schemes. But even in combination with the spectacular fiscal “bazookas” just deployed by a number of Western governments, this may not be enough to hold back the incoming tide of bankruptcies and debt defaults emerging from the sudden stop in the real economy.
There are three particular areas for concern here. First, it is a cruel irony that the country most heavily affected by the pandemic – Italy – also happens to carry the largest sovereign debt load in Europe (and the fourth largest in the world). The Italian banking sector, still overburdened by non-performing loans and heavily exposed to its own government’s debt, also happens to be one of the most fragile on the continent. According to a Financial Times analysis, Italy’s ongoing economic collapse therefore poses an “existential threat” to the Eurozone and the European financial system.
A second area of concern relates to the rapidly rising debt levels in developing countries and emerging markets. Last December, well before the outbreak of the coronavirus epidemic was even officially recognized, the World Bank already warned of the risk of a major global debt crisis, amidst the “largest, fastest and most broad-based” wave of debt accumulation in the Global South for the past 50 years.
According to the IMF, almost half of all Sub-Saharan African borrowers are now either at risk of debt distress or already in it. In Latin America, Venezuela is in default, Ecuador abandoned an IMF programme following mass protests last year, and Argentina is currently engaged in a complex renegotiation of its debt with Fund officials, just a year and a half after receiving the largest IMF bailout in history. Lebanon suspended payments on a $1.2 billion eurobond a few weeks ago. More countries will inevitably follow.
So far, emerging markets have been particularly hard hit by the investor panic in response to the public health emergency, experiencing a dramatic outflow of foreign funds since the start of the year. As Adam Tooze has noted, total capital flight from emerging markets reached $55 billion in the past eight weeks – double the rate seen at the height of the global financial crisis in 2008 or during the “taper tantrum” of 2013. If these outflows are not stabilised soon, a wave of debt defaults beckons.
Finally, the third area of concern has to do with the rapid buildup of debt among non-banking firms. In October last year, the IMF issued a dire warning over the $19 trillion corporate debt timebomb ticking away beneath the surface of the world economy. The Fund found that over 40% of corporate debt in eight leading economies would become unserviceable in the event of a downturn half as bad as the last one. The way things look now, we are actually on the verge of something far worse than that.
This year alone, some $2 trillion worth of corporate debt is due to be rolled over. But with credit markets freezing up and lenders refusing to extend new loans to businesses, many companies will undoubtedly fail to meet their payment schedules over the next months. Although US banks are now much stronger than they were back in 2008 and unlikely to fail anytime soon, the resultant wave of corporate bankruptcies will have severe knock-on effects on the unregulated shadow banking sector, which gobbled up trillions of dollars worth in risky corporate bonds during the central bank-fueled speculative boom of the past decade.
In a further twist, some of the most heavily indebted sectors with the largest bond payments falling due this year are also the ones most heavily exposed to the economic fallout of the pandemic: international airlines, European carmakers and American shale oil companies (the latter are doubly affected by the combination of falling demand for petroleum and the simultaneous oil price war launched by Saudi Arabia this month).
The corporate debt bubble will burst hard. According to a recent OECD study, more than half of all outstanding investment-grade corporate bonds had a BBB credit rating – just one notch above junk status. Furthermore, a significant share of publicly traded companies (16% in the US and 10% in Europe) were already considered “Zombie firms” prior to the pandemic; many of these are certain to go under in the coming debt deluge.
The coronavirus pandemic could therefore end up posing an existential threat not only to millions of human beings worldwide, but also to the debt-based financialised world economy whose recurring crises have come to define our era. Will the status quo be able to survive the unprecedented economic experiment of collective quarantines and national lockdowns around the globe? It is still too early to tell. But one thing is now abundantly clear: global capitalism finds itself at a critical juncture. The way in which this crisis is resolved will continue to shape the course of world history for decades to come.