The Coming Debt Crisis

Yves here. It would have been nice if the studies that looked at sovereign debt levels in addition to private debt had differentiated between sovereign debt issuers versus ones that have dollar pegs or borrowed in foreign currencies. Note also that Steve Keen has a more specific model about debt which looks at both the rate of growth in debt its absolute level. He found that if the growth of debt in China merely stopped, it would be in a world of hurt. But Keen anticipate the result would be zombification, as opposed to a bust.

Needless to say, what is striking is the rapid runup of borrowing in so many emerging economies, which are, generally speaking, fragile to begin with.

By Joseph Joyce, a Professor of Economics at Wellesley College, where he holds the M. Margaret Ball Chair of International Relations. He served as the first Faculty Director of the Madeleine Korbel Albright Institute for Global Affairs. Originally published at Angry Bear

After the 2008-09 global financial crisis, economists were criticized for not predicting its coming. This charge was not totally justified, as there were some who were concerned about the run-up in asset prices. Robert Schiller of Yale, for example, had warned that housing prices had escalated to unsustainable levels. But the looming debt crisis in the emerging market economies has been foreseen by many, although the particular trigger—a pandemic—was not.

Last year the World Bank released Global Waves of Debt: Causes and Consequences, written by M. Ayhan Kose, Peter Nagle, Franziska Ohnsorge and Naotaka Sugawara. The authors examined a wave of debt buildup that began in 2010. By 2018 total debt in the emerging markets and developing economies (EMDE) had risen by 54 percentage points to 168% of GDP. Much of this increase reflected a rise in corporate debt in China, but even excluding China debt reached a near-record level of 107% of GDP in the remaining countries.

The book’s authors compare the recent rise in the EMDE’s debt to other waves of debt accumulation during the last fifty years. These include the debt issued by governments in the 1970s and 1980s, particularly in Latin America; a second wave from 1990 until the early 2000s that reflected borrowing by banks and firms in East Asia and governments in Europe and Central Asia; and a third run-up in private borrowing via bank loans in Europe and Central Asia in the early 2000s. All these previous waves ended in some form of crisis that adversely affected economic growth.

While the most recent increase in debt shares some features with the previous waves such as low global interest rates, the report’s authors state that it has been “…larger, faster, and more broad-based than in the three previous waves…” The sources of credit shifted away from global banks to the capital markets and regional banks. The buildup included a rise in government debt, particularly among commodity-exporting countries, as well as private debt. China’s private debt rise accounted for about four-fifths of the increase in private EMDE debt during this period. External debt rose, particularly in the EMDEs excluding China, and much of these liabilities were denominated in foreign currency.

The World Bank’s economists report that about half of all episodes of rapid debt accumulation in the EMDEs have been associated with financial crises. They (with Wee Chian Koh) further explore this subject in a recent World Bank Policy Research Paper, “Debt and Financial Crises.” They identify 256 episodes of rapid government debt accumulation and 263 episodes of rapid private debt accumulation in 100 EMDEs over the period of 1970-2018. They test their effect upon the occurrence of bank, sovereign debt and currency crises in an econometric model, and find that such accumulations do increase the likelihood of such crises. An increase of government debt of 30 percentage points of GDP raised the probability of a debt crisis to 2% from 1.4% in the absence of such a build-up, and of a currency crisis to 6.6% from 4.1%. Similarly, a 15% of GDP rise in private debt doubled the probability of a bank crisis to 4.8% if there were no accumulation, and of a currency crisis to 7.5% from 3.9%. (For earlier analyses of the impact of external debt on the occurrence of bank crises see here and here.)

Kristin J. Forbes of MIT and Francis E. Warnock of the University of Virginia’s Darden Business School looked at episodes of extreme capital flows in the period since the global financial crisis (GFC) in a recent NBER Working Paper, “Capital Flows Waves—or Ripples? Extreme Capital Flow Movements Since the Crisis.”  They update the results reported in their 2012 Journal of International Economics paper, in which they distinguished between surges, stops, flights and retrenchments. They reported that before the GFC global risk, global growth and regional contagion were associated with extreme capital flow episodes, while domestic factors were less important.

Forbes and Warnock update their data base in the new paper. They report that has been a lower incidence of extreme capital flow episodes since 2009 in their sample of 58 advanced and emerging market economies, and such episodes occur more as “ripples” than “waves.” They also find that as in the past the majority of episodes of extreme capital flows were debt-led. When they distinguish between bank versus portfolio debt, their results suggest a substantially larger role for bank flows in driving extreme capital flows.

Forbes and Warnock also repeat their earlier analysis of the determinants of extreme capital flows using data from the post-crisis period. They find less evidence of significant relationships of the global variables with the extreme capital flows. Global risk is significant only in the stop and retrenchment episodes, and contagion is significantly associated only with surges. They suggest that these results may reflect changes in the post-crisis global financial system, such as greater use of unconventional tools of monetary policy, as well as increased volatility in commodity prices.

Corporations can respond to crises by changing how and where they raise funds. Juan J. Cortina, Tatiana Didier and Sergio L. Schmukler of the World Bank analyze these responses in another World Bank Policy Research Working paper, “Global Corporate Debt During Crises: Implications of Switching Borrowing across Markets.” They point out that firms can obtain funds either via bank syndicated lending or bonds, and they can borrow in international or domestic markets. They use data on 56,826 firms in advanced and emerging market economies with 183,732 issuances during the period 1991-2014, and focus on borrowing during the GFC and domestic banking crises. They point out that the total amounts of bonds and syndicated loans issued during this period increased almost 27-fold in the emerging market economies versus more than 7 times in the advanced economies.

Cortina, Didier and Schmukler found that the issuance of bonds relative to syndicated loans increased during the GFC by 9 percentage points from a baseline of 52% in the emerging markets, and by 6 percentage points in the advanced economies from a baseline probability of 28%. There was also an increase in the use of domestic debt markets relative to international ones during the GFC, particularly by emerging economy firms. During domestic banking crises, on the other hand, firms turned to the use of bonds in the international markets. When the authors used firm-level data, they found that this switching was done by larger firms.

The authors also report that the debt instruments have different characteristics. For example, the emerging market firms obtained smaller amounts of funds with bonds as compared to bank syndicated loans. Moreover, the debt of firms in emerging markets in international markets was more likely to be denominated in foreign currency, as opposed to the use of domestic currency in domestic markets.

Cortina, Didier and Schmukler also investigated how these characteristics changed during the GFC and domestic bank crises. While the volume of bond financing increased during the GFC relative to the pre-crisis years, syndicated bank loan financing fell, and these amounts in the emerging market economies fully compensated each other. In the advanced economies, on the other hand, total debt financing fell.

The global pandemic is disrupting all financial markets and institutions. The situation of banks in the advanced economies is stronger than it was during the GFC (but this could change), and the Federal Reserve is supporting the flow of credit. But the emerging markets corporations and governments that face falling exports, currency depreciations and enormous health expenditures will find it difficult to service their debt. Kristalina Georgieva, managing director of the IMF, has announced that the Fund will come to the assistance of these economies, and next week’s meeting of the IMF will address their needs. The fact that alarm bells about debt in emerging markets had been sounding will be of little comfort to those who have to deal with the collapse in financial flows.

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  1. H. Alexander Ivey

    Doesn’t anyone read Hudson? The problem with EMDE debt is not the corrupt and incompetent natives (the EMDEs), it is the greedy, corrupt, and incompetent US and UK shadow and regulated banks and financial institutions.

    I’m sitting here in Singapore, under a lockdown that would make most American 10%ers run screaming for their guns and lawyers, that is largely exacerbated by how those two countries are handling this pandemic.

  2. Terence Dodge


    “fragile to being with.” fragile to begin with?

    Perhaps my english is off! Delete this as as you need.


  3. Ashburn

    And yet in the midst of all this: 16 million suddenly unemployed, front line healthcare workers, grocery, and transit workers dropping dead for lack of PPE, the stock market is celebrating because the corporate coup is succeeding beyond their wildest dreams. The Democratic and Republican wings of the corporate Congress are merely squabbling over how much money to shovel to the corporations and small businesses. The Wall Street banks and corporations are celebrating safe in the knowledge that, thanks to our corporate Congress and the Fed, they will emerge from this crisis larger and more powerful than before, while the working class (those who survive) will be crushed by debt.

    1. The Historian

      Yep, we can feel the freight train bearing down on us but apparently Wall Street can’t. But as Wolf Richter says: “Nothing goes to heck in a straight line.”

      Wait a couple of months until all that stimulus money has been spent and Wall Street is begging for more.

      1. Susan the other

        That’s because Wolf is invested in zig-sags. My amazement is that humans (beginning at least 5000 years ago – Hudson) started using “debt” as currency. Which equated over the years to debt as “money” (Grabber). But debt is no such thing. Debt as a burden is something we need to clearly disavow. And money is something we need to use to accomplish – debt free – the things society needs. But not the things that are patently ridiculous. How did debt become legalized far beyond any usefulness? How was debt allowed to be mismanaged to an incomprehensible art form? Well…. duh. Here’s a good question: Is debt the same thing as adenosinetriphosphate? Some biologist asked this the very first day, long ago, that I found NC. ATP is the molecule’s energy that allows amoebas to colonize and thrive. It’s a source of energy in their “society” which is a semi-permeable society. Ours is a brick wall society – and it has taken us this long to realize what money/energy/debt is. It isn’t weird spending habits, it is only energy. Weird spending habits are sanctioned by the weirdos in congress. And money is created in the first place by society as a form of generosity. So why do people pay for money? I think we have come to the point where we can successfully understand the limits to any spending in terms of a circular on-going mechanism of support for society – in terms of the benefit to society. So why are we screwing around like this? We still seem to think debt is a thing. It isn’t. It isn’t a goddamned thing at all.Not to mention that we don’t even have any environmental riches left to exploit – let alone exploitable people. It’s all just so very over.

        1. JTMcPhee

          But people with power can force indebtedness, and then use force to collect those debts. Kind of hard to break that lock.

          And even if it might happen, at some point, the effing financialism now infects our cultural DNA, so even if there were some kind of discontinuity, like a “force majeure” Jubilee in the collapse of all the current financial structures, the “record” includes all the information that another set of Bezos and Rothschild and Dimon and their servitors like Obaaaama and Geithner will be able to restart the mechanism.

          I would like to be wrong, of course…

          1. Philip Hardy

            @JTMcphee No you are right, the bronze age civilisation debt jubilees that Hudson documents had to be repeated every so many years. Like most economic ideas, debt money is a bad idea which makes a few people very rich and powerful and therefore as an idea it has a constituency that make the idea persist. Only societies with a powerful religious sentiment against usury held it in check, Christianity and Islam for 1000 years did so. In 1492 the discovery of the Americas let usury off the leash, colonisation of the rest of the world followed by industrial revolution meant economic growth would pay the costs of usury, while most of the debtors could profit from borrowing. That situation is now coming to an end as fossil fuels and extractable resources are winding down, and other countries are difficult to conquer. At some point the debt mountains will collapse, that is the point at which to stop the usurers with religious ferocity!

  4. lordkoos

    “…so many emerging economies, which are, generally speaking, fragile to begin with.”

    Were not the economies of more developed nations also fragile? The US economy seems to be running on bailout after bailout.

    1. JTMcPhee

      Aren’t the economies of “emerging nations” just the consumer and financialists froth built on maybe ugly, by suburbia’s lights, but simpler and more resilient political economies?

      The farmer and the village can be pretty resilient, until Monsanto/Bayer moves in and the IMF feeds the insatiable greed and self-indulgence of “locals” who by violence and/or industrial-scale corruption and staying on task, manage to become the looters at the top of “government?”

      I love the figure of speech being used to frame what is supposed to happen next — “re-starting the economy,” as if “the economy” is a tractor that has stalled because its battery died from a short in the wiring , and all that is needed is some kind of new battery and someone to turn the switch…

  5. Sound of the Suburbs

    The economics of globalisation has always had an Achilles’ heel.
    The 1920s roared with debt based consumption and speculation until it all tipped over into the debt deflation of the Great Depression. No one realised the problems that were building up in the economy as they used an economics that doesn’t look at private debt, neoclassical economics.
    Not considering debt is the Achilles’ heel of neoclassical economics.

    What could possibly go wrong?
    I bet you’ve got a good idea already.

    “That’s handy Harry. We’re bankers and our only real product is debt”
    The bankers have found the Achilles’ Heel in the economics of globalisation and have been filling their boots.

  6. EMtz

    Not all EMDEs are piling on the debt. The President of México, Andres Manuel Lopez Obrador, equates debt as ceding sovereignty to the bankers and has dug in against printing more pesos despite enormous pressure from all sides. Instead, he has infuriated more than a dozen large corporations here by demanding that they pay billions in long overdue taxes that previous neoliberal administrations let slide. That money would fund not only the entire small business support program but also the salaries of the thousands of workers these and other companies have laid off over the past two months plus a large percentage of the health care costs of treating Covid-19 patients and creating jobs for the poor who constitute almost half the population. While the US recorded a government debt equivalent to 107% of GDP in 2019, México’s was 55%. If AMLO manages to pull this off he will have gone a long way towards enabling México to chart its own course apart from the banks, the ratings agencies and the corporatocracy. It’s a big risk, but one well worth taking imo.

  7. Jeremy Grimm

    There are many reasons the emerging markets and developing economies take on debt but the 2008 financial crisis is a big reason many of them had to assume heavier loads of foreign debt, much of it denominated in dollars. The onset of the COVID-19 pandemic created a tremendous global demand for dollars or their equivalent and put significant pressures on the U.S. treasuries markets. [I am still trying to wrap my head around the way the world trade flows work and can claim no expertise — I am parroting what I can of Adam Tooze’s most recent essays and recent essays by Nathan Tankus.] This post didn’t appear to mention [or I missed where it was mentioned] that many of the emerging markets and developing economies that could only obtain dollars by assuming new dollar denominated debts — since they are not flush with reserves of U.S. Treasury notes to exchange at the repo window, and have limited access to the FED’s repo window — many of those emerging markets and developing economies have not yet experienced the COVID-19 pandemic. The COVID-19 pandemic will add further strains to their economies and their ability to repay their dollar debts. Tooze expressed particular concern for South Africa, but many other of the emerging markets and developing economies could take some crushing blows as the pandemic spreads across their borders.

    The tenor of this post leaves me with an uncomfortable feeling. I sense a bloodless quality to the thinking which forebodes a wave of austerity to follow the huge ongoing blowup of fiscal deficits across the advanced economies much like that following the Financial Crisis of 2008. I could not guess what it could mean in the emerging economies.

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