The year 2020 was unprecedented in more aspects than one. The Covid-19 situation and the response from the global economies and their governments had lasting monetary consequences, not just countries but the world in general. The Institute of International Finance (IIF)– an association of various players in the global financial services industry, has released a report stating that the pandemic response added $24 trillion to the already climbing global debt. This drew the global debt levels to an all-time high of $281 trillion by the end of 2020 creating all the situations for a huge crisis impending ahead.
Statista reports global GDP in 2019 at $ 87.55 Trillion. That puts the debt at over 300% of the overall global GDP. That is an alarming ratio considering that debt is predicted to rise further in the coming months of 2021 as countries begin preparing for the post-covid world, including logistical challenges of vaccinating their respective populations.
So what does this rising debt level indicate about world economics and the state of governments? Is it just a figure having no implications, or will there come a time when lenders will come barging down on indebted countries? How much of a concern should this rising global debt be?
We shall explore every question in depth in this article.
Why do Countries borrow money?
Countries have historically borrowed money mainly for the purposes of fighting wars, but in the last 100 years or so, debt has been raised to streamline the economy and to maintain optimum levels of production and consumption. This can construct a false notion that an economy is doing well and is maintaining or even surpassing its previous levels of production and growth.
Government always spends more than it earns in taxes. It is not possible to increase the income by asking people to pay more in taxes due to political pressure. Increased taxes can impact the vote count of the leader.
How do governments borrow?
Government bonds are in effect “I owe yous” that indicate that a certain amount of money, as mentioned in the bond certificate, has been borrowed and will be paid back within the designated period at the decided coupon/interest rate. Historically, government bonds have been considered one of the safest financial instruments one can invest in. This is due to the safety of getting back the principal and interest amount with minimum risk of default.
Government bonds once released into the market can be readily exchanged between parties akin to how shares of a company trade hand. Bonds are bought by many different investors- both individuals and institutions including retail investors, pension funds, hedge funds, and even central banks of countries.
Foreign governments also buy bonds.
The holders of the majority of the public debt of the US government are China and Japan.
The History of Global Debt Crisis
The International Monetary Fund (IMF) in its report on ‘History of World Debt’ gives a chronological development of the rise and fall of global debt levels from way back in 1880.
This report helps us understand not only how world events have influenced borrowing and spending by countries but also the reasons for which countries usually borrow funds. It helps us understand the gravity of the situation at hand and why a global debt of $281 trillion in 2020 should not be considered trivial.
1880 to 1913
During the first era of globalization and industrialization, world debt was low with private capital inflows and trade flows spurring growth rather than debt. This brought overall debt to 29% of global GDP by 1913.
1914 to 1945
Debt reached an all-time low at 23% of GDP in 1914 – soon before World War I. Global debt began to climb throughout this period, with countries borrowing for the purposes of war. Reduction in debt in the 1920s was followed by two further spikes linked to The Great Depression (early 1930s) and World War II (1939-1945).
Owing to several episodes of banking and currency crisis, overall debt grew to 150% of global GDP.
2007-2008 Housing Market Crash
The recent failure of Lehman Brothers and other financial institutions owing to the housing market bubble, although not as grave as the depression back in 1932, pushed up global debt again. This time it impacted the developed nations heavily as well including the G-20 nations.
How serious is the current situation of record global debt?
Many economists and experts believe that rising global debt leads to a rise in inflation and such a trend has been observed in the past. Injecting extra funds into the economy through money that is borrowed, leads to overspending and high demand, thus directly influencing the price of everyday commodities.
Currently, interest rates on government bonds all around the world are falling. However, if they were to suddenly rise, would put governments in deep trouble since they would have to repay those borrowed funds at higher interest rates.
The world is drowning in debt. Poorer countries with no history of public borrowings and/or bad credit-worthiness continue to face trouble borrowing money in the public markets and thus face a more severe situation post-pandemic. Whether the countries are able to pay-off this climbing debt or continue to ‘balloon’ the figure is something we will find out in the coming years as nations begin re-vitalizing pandemic-stricken economies.
Stay tuned to Uncut Globe as we continue to cover the developments in global debt figures of 2020 and ahead.