WORLDVIEW: The next credit crisis is coming

Every day, I get a fabulous, data-filled newsletter from The Wall Street Journal called The Daily Shot – as a paying Premium subscriber, you can sign up for it too. Over the weeks, I have started to notice a global pattern: debt is out of control.

In America, the Trump administration’s increased spending and massive tax cuts are set to send U.S. borrowing skyrocketing and in China debts are mounting to dizzying heights. Meanwhile, in emerging markets, debt levels have risen dramatically.

The borrowing boom reminds me of our most-recent crisis – the sub-prime mortgage disaster of 2007. It also reminds me of the Latin American debt crisis and the U.S. savings and loan crisis of the 1980s, the junk bond crash of 1989, and the Asian financial crisis of the late 1990s.

All of these global financial meltdowns were, in one way or another, the result of a massive debt build-up. Today, it looks like we might be heading for another one.

Of course, we are not very good at predicting future financial disasters. Or, more accurately, we’re not good at picking the correct predictions and acting on them.

Before the sub-prime mortgage crisis there were plenty of journalists, bankers, and academics waving red flags over those markets. But the sup-prime market was just one among many that people were worrying about and no one took any action. Similarly, today, there are people shouting about a bunch of debt-related risks in different places. We just don’t really know where the knock-out blow will come from. Nevertheless, here are some key contenders.

  1. Meltdown in Chinatown

Last year, the IMF warned that corporate and household indebtedness in China was high and rising fast. According to Bloomberg, “Bloomberg Economics economists Fielding Chen and Tom Orlik estimate China’s total debt will reach 327% of gross domestic product by 2022.”

Economist Daniel Lacalle recently shared this chart, which shows that total Chinese debt already stands at over 300% of GDP. That’s high by any standard.

China is expected to account for over 35% of global growth in the next two years. A credit disaster in China could scuttle growth and damage everyone around the world that relies on Chinese inputs or consumers.

  1. Emerging markets haymaker

Emerging market debt issuances, including paper from companies, banks, and governments, has hit record highs and investors have been flocking into high-yielding emerging market paper.

But the IMF has warned that some countries may struggle with repayments as their indebtedness reaches new highs. Emerging market debt has knocked out the global financial system before. Could it do it again?

  1. American smack-down

Given America’s status as global top dog, it’s unlikely that you and I will live to see U.S. debt meltdown the way Argentina’s has. But that doesn’t mean that the build-up of American debt doesn’t pose any risks.

Since the financial crisis, American companies have piled their plates high with loans. Up to now, however, rising debts have not meant rising debt-service costs because of America’s ultra-low interest rates and high corporate earnings. Any change in the status quo, however, could mean pain for U.S. businesses and, by extension, global stock markets.

On the sovereign side, the U.S. government is on track to hit over $33 trillion in debt in the next ten years thanks to rising spending and massive tax cuts. The flood of Treasury issuances has been setting some traders on edge and there are signs of weakening demand for T-bills. This means higher coupons on new Treasuries and a heavier debt payment burden for the U.S.

Bloomberg estimates that by 2025, America will be spending more on interest payments than anything else. All of this debt is going to act as a brake on American growth, which will, in turn, drag down global growth. A slow-moving American debt crisis will look like a few lost decades for the world.

And there you have it: some of the big contenders for the source of the next credit crisis. Who would you put your money on? – Felicity Duncan