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An expanding trade war threatens to squeeze incomes.
An expanding trade war threatens to squeeze incomes.

$247 Trillion Global Debt and Trade War, a Dangerous Mix

$247 Trillion Global Debt and Trade War, a Dangerous Mix

The untold story of the world economy—so far at least—is the potentially explosive interaction between the spreading trade war and the overhang of global debt, estimated at a staggering $247 trillion.
Households, businesses and governments borrow on the assumption that they will service their debts either by paying the principle and interest or by rolling over the debts into new loans. But this works only if incomes grow fast enough to make the debts bearable or to justify new loans.
When those ingredients go missing, delinquencies, defaults and (at worse) panics follow, RealClear Markets reported.
Here’s where the trade war and debt may intersect disastrously. Since 2003, global debt has soared. As a share of the world economy (gross domestic product), the increase went from 248% of GDP to 318%. In the first quarter of 2018 alone, global debt rose by a huge $8 trillion. The figures include all major countries and most types of debt: consumer, business and government.
But to service these debts requires rising incomes, while an expanding trade war threatens to squeeze incomes. The resort to more tariffs and trade restrictions will make it harder for borrowers to pay their debts. At best, this could slow the global economy. At worst, it could trigger another financial crisis.
Note that the danger is worldwide. It’s not specific to the United States. In a new report, the Institute of International Finance, an industry research and advocacy group, says that the debts of some “emerging market” countries (Turkey, South Africa, Brazil, Argentina) seem vulnerable to roll-over risk: the inability to replace expiring loans. In 2018 and 2019, about $1 trillion of dollar-denominated emerging-market debt is maturing, says the IIF.
Debt can either stimulate or retard economic growth, depending on the circumstances. “Now we’re approaching a turning point,” according to Hung Tran, the IIF’s executive managing director. If debt growth is not sustainable, as Tran believes, new lending will slow or stop. Borrowers will have to devote more of their cash flow to servicing existing debts.
 Inflation Rising
Inflation is also creeping up. To stall its rise, the fed is raising interest rates. Trade protectionism compounds the problem, because many non-US companies borrow in dollars. And these loans must be repaid in dollars. If tit-for-tat protectionism dampens trade, getting those dollars will become harder. Loan delinquencies and defaults may rise.
Tran isn’t predicting a full-scale panic resembling the 2008-09 financial crisis, and there are some reasons for optimism. Banks are better capitalized now than before the crisis. (Bank capital—shareholders’ funds or loans—protect against losses.) People are also more sensitive to the dangers than a decade ago.
Evidence of this comes from a recent “stress test” performed on 35 large bank holding companies by the Fed. A deep recession was simulated; the unemployment rate rose to 10%. Despite large losses, no bank failed. Since 2009, these banks have added $800 billion in common equity capital, says the Fed.
What Tran is suggesting is a global shift away from debt-financed economic growth. The meaning of the $247 trillion debt overhang is that many countries (including China, India and other emerging-market countries) will be dealing with the consequences of high or unsustainable debts—whether borne by consumers, businesses or governments. There will be a collective impact on the global economy.

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