The global ‘debt-bomb’: An analysis of the dynamics and instabilities that threaten to bring down the world's economy. International debt is often compared to a ticking time-bomb: everyone knows it’s set to go off, but no one knows exactly how or when. Since financial experts themselves cannot foretell a major debt crisis, the global public has good reason to be confused. The thought of losing their wealth in a global credit collapse is so overwhelming and contrary to experience that many people refuse to consider what may be fueling this ‘debt-bomb’ and the steps necessary to dismantle it. On a personal level, many individuals are just as perplexed about the significance of their own debt. Only three generations ago, anyone holding a credit tab was treated with scorn, and guilt-ridden debtors were shut out of numerous social and financial opportunities enjoyed by solvent citizens. Likewise, having no credit record today is a taboo of market disapproval that makes non-borrowers feel anxious for the economic privileges available only to those who make debt payments. What accounts for this startling reversal in cultural attitudes? A sea-change in international finance during the past 30 years has transformed bank lending from a routine process of balancing debt payments for local development into a prime engine of global economic growth. Just as Western governments have changed their fiscal strategies from balanced budgets to deficit spending and monetary expansion, citizens who once believed in the sober disciplines of personal saving and ‘paying as you go’, are now sold on the instant gratification of easy credit and deferred payments. Borrowing is no longer shameful, it’s savvy. But how will history judge this present era of convenient financing? Is debt really good for the economy? And just how serious is this global ‘debt-bomb’? Superpower with a ‘Third World economy’ The term ‘global debt’ is usually associated with the delinquent loans and sovereign defaults of developing nations, and the payment losses that these bankruptcies cause international lenders. “The heart of the debt problem,” said the Brandt Commission, “is that a very large proportion of funds are lent on terms which are onerous for borrowers from the point of view of both the repayment capacity of the projects they finance and the time debtor countries need to correct structural imbalances in their external accounts.” (N-S, 223) Since the volume of Third World debt has quadrupled during the past two decades, a much wider circle of stakeholders is exposed to the risk of government insolvency than before. In the Latin debt crisis of the 1980s, international banks held the debts of defaulting countries and paid the bulk of the bill (Share International, March 2003, pp10-11). In the 1990s’ Asian crisis, the failed loans were owned by the banks, along with insurance companies, mutual funds, and pension funds held by millions of investors; the bailouts by the IMF consisted mostly of G-7 public monies (SI, April 2003, pp21-22). Now, however, with the increasingly unregulated integration of global trade, financial, and currency transactions, the powder-keg of global debt rests squarely on the doorstep of the world’s largest debtor, America; and since the next major credit crisis may involve not only the world’s lending and investment institutions, but also the world’s central banks and their currencies, virtually everyone on the planet who uses money would be affected. The external debt of the United States today is nearly $3 trillion — roughly the same debt level of all developing nations combined. But because the dollar is the foreign currency of choice in nearly every nation — allowing America to borrow in its own currency and to sway international exchange rates and interest rates to its advantage — US interest payments on its foreign debt are far less than the payments of developing countries. American debt, in other words, is heavily subsidized by the dollar-denominated loans and investments of foreign nations. Fiercely proud of her political independence from the forces of globalization and multilateralism, the United States is nevertheless the most economically dependent nation in the world. And with the Third World debt bubble so intricately linked with the American debt bubble, a credit disaster in one area could spread quickly to both hemispheres. Today, the global economy is vulnerable in several areas:
· · · · · · · · · This is the short list of trouble spots. Deflation or currency devaluation in these or other regional flashpoints could set off another round of financial contagion, triggering a vicious round of panic and capital flight across the world. In a third international debt crisis, the size of the rescue operation required would be enormous, especially if rich nations join poor ones among the victims. While the major developed countries were fairly insulated from the previous debt crises in Latin America and South-east Asia, several factors are now undermining that protection. In every global slowdown during the past 20 years, there was always one market in the world strong enough to save the others from recession by buying their products. After the international currency crises of 1997-1998, the United States acted as the global consumer of last resort, lifting the world from an economic downturn. While many countries now look to the $10 trillion American economy to generate another round of global economic expansion, history is not likely to repeat itself.
Although the US remains the center of global trade and investment, its economy has been sluggish until recently. The fall in the dollar exchange rate has made some American exports more attractive in world markets, but many US manufacturers still face tenacious competition on imports from Asian nations whose currencies are pegged to the dollar. American consumers continue to borrow and spend, but not vigorously, due to mounting job losses, rising household debt and a low saving rate. Consumer spending and business investment are also down across the world. Excluding China, global industry is operating at only two-thirds of capacity. Growth rates in world trade are at their lowest in two decades, increasing just 1 per cent in 2001 and 3 per cent in 2002, down from a 12 per cent increase in 2000. Concerns over terrorism and war have also limited global trade growth to about 5 per cent in 2003. With the heavy erosion of its industrial base, the US began running a trade deficit in the 1980s. Because it exports only half as much as it imports, the United States now borrows (US) $2 billion a day from abroad to finance its appetite for foreign goods and services. As a consequence, America’s domestic savings are dwarfed by overseas investment into the US, raising apprehension among some economists over the sustainability of the US current account deficit (a statistic which combines the difference between America’s present imports and exports, with the interest payments that the US owes on earlier loans from foreign nations). This huge current-account deficit (US $600 billion), along with America’s enormous private sector debt (US $5 trillion), and its ballooning federal budget deficit (US $455 billion in 2003), pose a significant danger to the global economy. What happens if the United States loses its reputation as the world’s haven for secure investment? Foreign equity investors, with (US) $8 trillion tied up in US assets, are carefully watching America’s lackluster corporate earnings, low interest rates, and other indications of currency or valuation weakness. Foreign capital has already begun to flee the United States for related reasons: · the collapse of the dot.com stock market · corporate accounting fraud · unsustainable credit expansion · budget crises in state governments · intensive deregulation and elimination of social safety nets · tax cuts aimed at reducing the size of the US Government, but growth in fiscal spending resulting in bigger government · US military overcommitment and unilateralism There is mounting concern around the world that the highly-leveraged US economy may not be able to service its debt obligations indefinitely. Even if America could continue to increase its global borrowing and postpone the inevitable adjustment of its trade, financial, and currency imbalances with foreign nations, international investors are not likely to continue holding sizeable amounts of American debt for much longer. If the perceived risks of US foreign debt and American currency depreciation continue to grow, and significant numbers of overseas investors switch their funds out of US financial markets into more attractive options such as euro-denominated assets, the value of the dollar could sink rapidly. This would cause the stock market to plunge, liquidity to shrink and the housing market bubble to burst. The American economy would grind to a halt, with destabilizing effects across the globe. In developing nations, a steep drop in the dollar would also decrease trade, raise interest rates, decrease foreign investment, and slow output growth. As American demand slumps, nations which export to the US will be unable to meet their debt service commitments, particularly to American financial institutions, leaving the US currency vulnerable to collapse. What will replace America as the major driver of global growth? Europe and Japan have been teetering in and out of recession, with no upturn in sight. Asia, Latin America, the Middle East and Africa, which are heavily leveraged on the growth of the rich nations, are also struggling with recessionary conditions. Though foreign corporations have increasing access to China’s 1.3 billion consumers, and in spite of her booming exports and spectacular 8 per cent growth in recent years, Chinese purchasing power is relatively flat due to its undervalued currency (the yuan), government restrictions on domestic trade and investment, and more than $500 billion of unpaid debt in state-owned banks (50 per cent of all outstanding loans in China are non-performing). Low wages in China are also driving international deflation by undercutting world prices on exports, forcing foreign producers to lower their prices. Everyone is waiting for a release of pent-up consumer demand and a surge in global business investment. World spending increased substantially in the latter half of 2003, but the frank outlook among many economists is for rising unemployment, stagnant growth, and increased currency volatility. Without a white knight on the horizon to stimulate international capital spending, excess productive capacity and a prolonged slump in buying could lead to a downward spiral in global prices and demand, gradually engulfing every local economy. Dependent on massive inflows of foreign capital that have been declining since 2001, the United States must make a fateful decision. To substitute domestic savings for these foreign savings (which presently finance the trade gap between America’s imports and exports, as well as US household, business and government debt), the United States would have to slash its national spending and fiscal growth dramatically. A cheap dollar would allow America to shift its spending away from foreign imports toward domestically produced goods and the expansion of US exports. Painful as that may be, it would help avert a major currency crash, reduce America’s trade and debt imbalances with foreign nations, and eventually put America back on the path of sustainable economic growth. But America appears committed to a different course. Besides cutting taxes and interest rates, the US has chosen to increase military spending to provide a fiscal stimulus, while seeking global opportunities to use its powerful new weaponry. This is a particularly delicate issue, since the geo-political backlash caused by military escalation and armed intervention in other nations — whatever the justification — could itself roil world markets and ignite the fuse of the global ‘debt-bomb’ (by dampening foreign spending and trade, causing the dollar to crash and triggering erratic swings in international exchange rates). The Brandt Commission, chaired by Willy Brandt, who won the 1970 Nobel Peace Prize for negotiating a historic peace agreement between the Soviet Union and the West, cautioned against the domestic build-up of armaments to generate economic growth, since military spending is not an adequate substitute for effective long-term demand. “In fact military expenditure is very much more a part of the world’s economic problem than its solution,” said Brandt. “At any given level of public expenditure, the higher the proportion of spending devoted to weapons procurement, the smaller the amount of employment created. Military expenditure may also be more inflationary than other public spending. The alleged benefit of technological spin-off is also fallacious; technological advance can be promoted directly with far greater economy.” (CC, 43) At the same time, the Brandt Commission observed, the purchase of armaments by developing nations for security purposes is economically destabilizing for them as well: “As massive arms imports require an adequate infrastructure, absorb scarce labour and additional foreign exchange for maintenance, this all increases debt burdens.” (N-S, 121-22) Defuse the ‘debt-bomb’ or face a chaotic aftermath? Growing numbers of economists agree that unpayable debt contributes to the world’s social, political and economic instability more than any other single factor. Excessively strict lending policies affect developing nations the most since they have the fewest resources and the greatest needs, yet are still required to borrow and make payments at market rates. So lending is not the real problem; the problem is in its application. “Debt is the result of borrowing,” said the Brandt Commission, “and developing countries’ debt should not in itself be regarded as something undesirable. It is undesirable when borrowed capital is not adequately used to enhance productive capacity, or when the average terms of debt are not commensurate with the borrower’s capacity to repay, and lenders fight shy of lending more.” (CC, 45) Poor countries need loans to help them develop, and global capital is always looking for projects to finance. It seems like a perfect marriage. But since monetarism* became the world’s economic operating system in 1971 (when the United States took the world off the fixed gold standard and allowed foreign currencies to float against the dollar, inaugurating an era of deregulation in global monetary, financial and trade policy), the volume of international money and credit has increased nearly 2,000 per cent, leaving developing nations defenseless against cyclical declines in global investment and production. By driving down wages, increasing unemployment, and raising national deficits, monetarist policies have been responsible for the credit bubbles and collapses that thwart the world’s productive capacity, slow spending and cause debt to grow faster than exports. Because lenders fear that poor nations may not meet their loan payments, and because lenders can make higher profits elsewhere, global lending to underdeveloped regions has slowed significantly in recent years. With international loans earmarked for capital markets at competitive interest rates, rather than for co-operative development on easier terms, this gigantic pool of money and credit fails to ‘trickle down’ into the hands of people in remote villages and overcrowded slums who live in conditions of extreme poverty, powerless to create healthy societies and strong markets without such assistance. If the dollar crashes during the next few years, developing nations will suffer yet another catastrophic drop in their export earnings (as developed nations undergo further recession and world trade contracts), along with a steep rise in interest rates (as foreign investors withdraw their money and the cost of international borrowing increases). In 1980, the Brandt Commission announced “a program for international action that would simultaneously assist the Third World and alleviate economic difficulties in the industrialized countries. Fundamentally, we require a set of measures which are designed to sustain effective demand in the world and promote an expansion of world trade. Such measures will help to ensure that deflation, balance-of-payments difficulties and default on debt are not widespread in the Third World.” (N-S, 240-241) Without a global macroeconomic program to tackle them, these three financial weaknesses — deflation, payments imbalances, and debt default — are spreading from developing nations to the entire international economy, just as the Brandt Commission predicted. Not only has the volume of international debt escalated during the past 20 years, but the problem of debt repayment is now affected by declining prices and sluggish growth in world trade, shrinking levels of global lending and credit available for development, and a lack of international financial safeguards to protect the world public from a major debt crisis. Careful international intervention by all nations is needed to defuse this ‘debt-bomb’ and create a stable international credit system to manage aggregate demand and stimulate the global economy. The credit plan proposed by the Brandt Commission is straightforward: · Cancel the debt of the poorest nations and reduce the debt of other developing nations · Expand the use of the IMF’s Special Drawing Rights as international reserve assets to ease debt payments and finance development programs, particularly in developing nations · Allow capital controls (domestic restrictions on outflows of foreign money) to stabilize the distribution of global credit · Create a Global Central Bank to regulate financial institutions, control the global money supply, adjust national trade and debt imbalances, and serve as a global lender of last resort · End domestic subsidies and tariffs so that developing nations can reverse their dependence on exports to finance their debts, and become self-reliant and equal trading partners with developed nations · Increase wages and purchasing power, especially in developing nations, to increase effective global demand. Not only would these measures rescue developing nations from debilitating poverty and unpayable debt, but they would also ensure long-term economic stability for developed nations. In addition, a strong and reliable global credit system would restore confidence in the international economy and prevent the mass disorder that may otherwise follow an explosion of the global ‘debt-bomb’, the breakdown of the world’s monetarist economic system, and attempts to exploit the resulting social and financial vacuum through militant insurgency or police action. “Any new loans on market terms, whether from the commercial banks, national governments, or the IMF, can help to alleviate the immediate crisis, but will only increase these countries’ indebtedness,” said the Brandt Commission. “Only a major recovery of the world economy and measures to ease debt service burdens could alleviate the situation. Prolonged and excessively severe measures to ensure debt payments can be ultimately counterproductive, leading to growing social unrest, impossible strain on governments and prospects of revolution or chaos.” (CC, 39-40) “War is often thought of in terms of military conflict, or even annihilation. But there is a growing awareness that an equal danger might be chaos — as a result of mass hunger, economic disaster, environmental catastrophes, and terrorism. So we should not think only of reducing the traditional threats to peace, but also of the need for change from chaos to order.” (N-S, 13) *Monetarism is an ideology championed by Friedrich von Hayek, Milton Friedman and other 20th-century economists. Basically, monetarists believe that any economic problem can be solved either by raising interest rates and contracting the amount of money in circulation (to stop inflation), or lowering interest rates and expanding the money supply (to prevent recession). For more information:
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