The Next Crisis: Debt
There will be one clear legacy from COVID-19, namely, debt.
In countries across the world, whether it be private households or public companies, the pandemic is causing revenues to shrink as its costs continue to mount up. For many, if not all, the only way out is through taking on debt. No other event since the Second World War has created such a dramatic rise in the level of debt as has the coronavirus.
Even before the outbreak, global debt had reached more than $250 trillion (230 trillion Euros). To put that in perspective that is about three times higher than the world’s annual combined gross domestic product. Yes, you read that right, and remember that was BEFORE coronavirus came among us. Now, as a result, governments around the world are issuing debt-financed bailouts worth trillions more. In the last weeks alone, as quickly as possible the European Central Bank (ECB) and other central banks are injecting money into the economy with virtually no limits to prevent a collapse.
The question on my mind, and now probably on yours, is all well and good, but how does this mountain of debt ever get paid back? And, more importantly, who is going to do the paying?
There are only two possible sources of repayment: companies and individual taxpayers. Yet, like never before companies have lost business in the last weeks – some possibly forever – and have been forced to take on debt and lay off employees. Ordinary people, now more unemployed than ever, in just nine weeks 39 million new unemployed in the United States alone, are going to be forced to pay back the loans so many of them have outstanding.
Installment credit is just part of so many Americans’ fiscal life – that it will be a problem of epic proportions there. It is perhaps inevitable that millions could default on their car, house and student loans. But in countries like Germany, this is also a factor thanks to low interest rates. And the real worry behind all this is not the debt mountain but the nightmare scenario that as people, companies, or even governments, go bankrupt then this hits the banks with such a force that it triggers a new credit crisis like the one that followed the collapse of Lehman Brothers in 2008.
Only this time, it could be far worse all round as the whole economic structure of the world we have known is under stress in a way no one could have envisaged a few months ago. The resultant coming recession, which as the UK Chancellor of Exchequer succinctly put as “like nothing we have seen before,” will be on such a massive scale involving every sector of the economy that it really is uncharted territory. So much so, that in some sectors, the losses that are now being incurred cannot be made up. What is not being made up is the fact that the coming crisis will cause company debt to rise so sharply and lead to so many insolvencies that we are about to have something very, very bad visited upon us.
As reported in various places, according to the Bank for International Settlements, no recession of the modern era will have crushed companies around the world as the shock from COVID-19 is set to do. Gloomily, it also states that without government assistance, half of all global businesses will not be able to pay back outstanding loans on time.
That is why the ECB has relaxed its capital rules and allowed European banks to grant up to 1.8 trillion Euros in additional loans. German corporations like Daimler, Bertelsmann and Eon have issued bonds worth more than 100 billion Euros since mid-March. Additionally, the Berlin government is providing loans and guarantees worth more than a trillion Euros through the state-owned development bank KfW. Within just five weeks, the bank received more than 25,500 applications for loans worth 33 billion Euros.
But this is only alleviating the immediate need for cash. The companies will eventually have to make good on their bonds and pay back KfW, plus any interest. If the economy bounces back many companies will enter the next phase with a heavy debt load. But no bounce is guaranteed and by many not predicted.
Yet, whether companies will even have time to recover from the crisis will depend largely on the banks. This will get interesting for banks as bad loans start piling up on their balance sheets. Then, just as in 2008 and 2009, which banks are strong enough to support ailing companies will become all too clear. Even before the coronavirus struck, European banks already had close to 600 billion Euros worth of non-performing loans on their books. In Greece, bad loans account for more than 30 percent of banks’ loan portfolios. In Italy, they account for 6.7 percent.
Concerns over banks’ stability has apparently also reached the political realm.
Because, in the end, national governments will be saddled with much of the risk. Governments just cannot allow a wave of bankruptcies among businesses or another crash in the banking sector as this would cause national debt all over the world to explode at a rate not seen in peacetime. This year alone, the International Monetary Fund (IMF) expects government debt burdens to hit $8 trillion.
These figures can all seem to blend into one: millions, billions, trillions. So let’s put it a different way – that level of debt is around 100 percent of annual global economic output.
In short, we owe more money than anything the world could ever produce in return. Therefore, we would not be able to pay this debt off – ever.
