Debts, Lack of Investments Point to Global Economic Slump

EghtesadOnline: The debts of the world capitalist economy and low profitability since 2009 have produced a long depression—where global growth remains below pre-crisis levels and growth in world trade has stalled.

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31 October 2016

Companies confronted by low profitability and high debts are reluctant to invest. Governments are burdened with debts from bailing out the banks, and as social security costs remain high, they cut state investment.

Households with large mortgages save rather than spend creating weak investment combined with low wage and employment growth, Xinhua reported.

Central banks have slashed interest rates towards zero so servicing debt is cheap. This low cost credit is used by corporations to buy back shares, pay dividends and speculate in stocks and bonds; governments to service their bonds and borrow more; and households to pay their mortgages and run up credit card debt.

However, the global debt hangover remains and if interest rates rise or economies suffer recession or deflation, this debt burden may spiral out of control.

Global Debt High

The IMF reports that global debt is at record levels. Non-financial sector (corporations, households and governments) debt has more than doubled since 2000, reaching $152 trillion last year. And the total debt exceeds $200 trillion if we include banks.

These debts are equal to 225% of the world GDP. Two-thirds of this is owed by the private sector, as household mortgages and corporate borrowing. The IMF identifies "a vicious feedback loop in which lower growth hampers deleveraging and the debt overhang exacerbates the slowdown."

The IMF identifies European banks as a major risk. They face a chronic profitability crisis and hold legacy debts. Investors fear that profitability will continue to elude them.

Banks' Financial Crash

Deutsche Bank, Germany's largest bank, faces massive fines from the American Justice department for "mis-selling" mortgage bonds to global clients during the US housing boom. The subsequent bust helped provoke the global financial crash. Deutsche Bank is close to the edge and it may be bailed out by public money.

Last summer, an IMF report on German banks concluded that "Deutsche Bank appears to be the most important net contributor to systemic risks in the global banking system," followed by HSBC and Credit Suisse. Deutsche has $47 trillion in the notional value of their derivatives outstanding. If it goes down, many other banks will go with it.

Italy's banks hold €200 billion ($209.7 billion) in bad loans from companies that cannot service their debts in the midst of Italian economic weakness and sluggish global growth. Italy's third biggest and oldest bank, Monte Paschi, is bust and has already had two bailouts. Portuguese banks also had to be bailed out.

Corporate Debt

Corporate debt is rising, particularly in emerging markets. The combined shock of plunging commodity-prices and China's slowdown makes the surge in private debt a major threat to emerging-market economies.

The investment bank JP Morgan reckons that the debt of non-financial corporations in emerging economies rose from 73% of GDP in 2008 to 106% of GDP now; a rise of nearly 5% a year. This means there is a heightened risk of a severe financial crisis. And many emerging market economies have experienced a similar increase since 2007.

Cheap Money Flow

In the major economies, governments tightened spending to reduce public deficits and debt burdens, while central banks cut interest rates and printed money, creating cheap money to pay off debts and encourage investment.

However, fiscal "austerity" and cheap money have not worked; a zero interest rate policy is being replaced by a negative interest rate policy and by quantitative easing—printing money to give it to the banks, according to Financial Tribune.

Now, the idea is to have "helicopter money" which would be printed and distributed directly to governments or households as if being scattered from a helicopter. But all this credit will build up in banks and flow into speculative financial investment, because the profitability of productive sectors remains too low to encourage new investment and consequently growth.