- Economists are beginning to worry about the sustainability of high debt levels as global interest rates rise sharply.
- A credit crunch could fuel “the mother of all economic crises”, warned Nouriel Roubini last week.
- Some experts have compared the current situation to the structural problems that triggered the financial crash of 2008.
As global interest rates rise at a staggering rate, economists are beginning to worry about the mountain of debt accumulated over the years as borrowing costs languished near zero.
Nouriel Roubini sounded the alarm bells last week, warning that the sharp rise in rates could erode the ability of households and businesses to meet their loan repayment commitments. He said it could trigger “the mother of all economic crises”.
Roubini echoed organizations like the International Monetary Fund and the World Bank, whose leaders have warned that rising debt burdens put the global economy in danger of sliding into a severe recession.
Concerns have grown over the sustainability of the US economy’s high debt levels, after the Federal Reserve raised its benchmark rate to 4% from a range of zero to 0.25% as well. recently than in March. Other central banks around the world have also hiked rates sharply to combat soaring prices.
Here’s why economists have begun to worry about the risk of a debt crunch – and why such an eventuality could lead to a stock market crash.
Why has global debt increased?
In the aftermath of the 2008 global financial crisis, central banks flooded the markets with cheap money by cutting interest rates to record lows and using a policy known as quantitative easing (QE) to buy trillions of dollars of financial assets.
Falling borrowing costs have made it easier for businesses, governments and ordinary Americans to take out loans and fueled the rise of what Roubini calls “zombies” – people and businesses backed by cheap debt. rather than sound finances.
And as interest rates have rebounded sharply this year, it is becoming increasingly difficult for these borrowers to repay their loans.
What’s going on with interest rates?
The Fed is raising interest rates in an effort to control inflation, which is nearing 40-year highs.
This monetary tightening campaign aims to lower consumer spending, which would help curb the rise in prices.
But it also increases the cost of borrowing, making it more expensive for individuals to take out a loan to buy a home, for companies to invest in their business, and for governments to spend on education or health.
It is also more difficult for indebted zombies to obtain financing.
What could happen next?
Roubini warned that a combination of rising debt, high inflation and weak growth would trigger a global economic crash – and stocks could fall another 25%.
Central banks like the Fed won’t be able to prevent an economic slowdown because consumer prices would rise faster if policymakers let up on tightening, he said.
“The mother of all stagflationary debt crises can be postponed, not avoided,” Roubini wrote in a Project Syndicate op-ed last week.
The IMF and World Bank have linked rising debt to increased instability, with the threat of a crisis potentially injecting more volatility into markets next year.
How would that compare to 2008?
It is natural for economists to draw comparisons between the current situation and the last major financial crisis.
In 2008, cheap credit and lenient lending standards helped fuel a housing bubble – and when it burst, prices plummeted and exposed banks went bankrupt.
Roubini drew comparisons between the accumulation of debt that worries economists right now and this global financial crisis, when stock markets quickly lost about half their value.
So, with war in Ukraine, rising interest rates and a looming recession dominating markets, a possible debt crisis could quickly blow up the long list of investor concerns for 2023.
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