3 minute read
Debt Crisis
DANIEL LACALLE is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.” Daniel Lacalle
Rate Hikes and Mounting Debt
The issue isn’t rate increases, but excessive debt and complacency
More than 90 central banks worldwide are increasing interest rates. Bloomberg predicts that by mid-2023, the global policy rate, calculated as the average of major central banks’ reference rates weighted by GDP, will reach 5.4 percent. Next year, the federal funds rate is projected to reach 5.15 percent.
Raising interest rates is a necessary but insufficient measure to combat inflation. To reduce inflation to 2 percent, central banks must significantly reduce their balance sheets, which hasn’t yet occurred in local currency, and governments must reduce spending, which is highly unlikely.
The most challenging obstacle is also the accumulation of debt.
The so-called “expansionary policies” haven’t been an instrument for reducing debt, but rather for increasing it. In the second quarter of 2022, according to the Institute of International Finance (IIF), the global debt-to-GDP ratio will approach 350 percent of GDP.
Global issuances of high-yield debt have slowed but remain elevated. All of the risky debt accumulated over the past few years will need to be refinanced between 2023 and 2025, requiring the refinancing of over $10 trillion of the riskiest debt at much higher interest rates and with less liquidity.
The United States has $31 trillion in outstanding debt with a fiveyear average maturity, resulting in $5 trillion in refinancing needs during fiscal 2023 and a $2 trillion budget deficit. Knowing that the federal debt of the United States will be refinanced increases the risk of crowding out and liquidity stress on the debt market.
According to The Economist, the cumulative interest bill for the United States between 2023 and 2027 should be less than 3 percent of GDP, which appears manageable. However, as a result of the current path of rate increases, this number has increased, which exacerbates an already unsustainable fiscal problem.
If you think the problem in the United States is significant, the situation in the eurozone is even worse. The majority of the European economies have issued negative-yielding debt over the past three years and must now refinance at significantly higher rates.
The magnitude of the monetary insanity since 2008 is enormous, but the glut of 2020 was unprecedented. Between 2009 and 2018, we were repeatedly informed that there was no inflation, despite the massive asset inflation and the unjustified rise in financial sector valuations.
In 2020-21, the annual increase in the U.S. money supply (M2) was 27 percent, more than 2.5 times higher than the quantitative easing peak of 2009 and the highest level since 1960. Negative-yielding bonds, an economic anomaly that should have set off alarm bells as an example of a bubble worse than the “subprime” bubble, amounted to over $12 trillion.
In the eurozone, the increase in the money supply was the greatest in its history, nearly three times the Draghi-era peak. Today, the annualized rate is greater than 6 percent, remaining above Mario Draghi’s “bazooka.” All of this unprecedented monetary excess during an economic shutdown was used to stimulate public spending, which continued after the economy reopened. And inflation skyrocketed. However, according to European Central Bank President Christine Lagarde, inflation appeared “out of nowhere.”
No, inflation isn’t caused by commodities, war, or “disruptions in the supply chain.” Wars are deflationary if the money supply remains constant. Several times between 2008 and 2018, the value of commodities rose sharply, but it didn’t cause all prices to rise simultaneously. If the amount of currency issued remains unchanged, supply chain issues don’t affect all prices. If the money supply remains the same, core inflation doesn’t rise to levels not seen in 30 years.
All of the excess unproductive debt issued during a period of complacency will exacerbate the problem in 2023 and 2024. Even if refinancing occurs smoothly but at higher costs, the impact on new credit and innovation will be enormous, and the crowding out effect of government debt absorbing the majority of liquidity and the zombification of the already indebted will result in weaker growth and decreased productivity in the future.
