2024-01-14 10:08:22
London, United Kingdom (CNN) — World leaders are flocking to Davos this week to talk about the most pressing problems facing planet Earth..
Two major wars, a shipping crisis, cyberattacks on nations’ institutions and more alarming evidence of the climate emergency mean there is no shortage of talking points.
But turning ideas into action when governments owe an unprecedented $88.1 trillion – roughly the equivalent of global annual economic output – will be difficult.
Public debt has exploded during the pandemic, and new borrowing this year is likely to break records in many major economies, making governments less able to respond to shocks such as financial collapses, pandemics or wars.
Even in the absence of a new crisis, rising debt servicing costs will hamper efforts to address climate change and care for aging populations. Public services in many countries are already under severe pressure following successive budget cuts.
Even more worrying is that as debt burdens increase, governments may find themselves unable to borrow more to service their existing obligations and adequately finance basic services.
Michael Saunders, a former member of the Bank of England’s monetary policy committee, said a government unable to finance its debt would be “forced to implement sudden and painful cuts” in spending or tax increases.
“Such a government may lack the fiscal space to respond to future negative shocks, preventing fiscal support when it is needed most,” he told CNN.
Saunders, now a senior economic adviser at consultancy Oxford Economics, does not believe rich economies are approaching roughly the equivalent of a personal credit limit, and points to investors’ continued appetite for government debt. But that doesn’t mean the limit won’t be tested 10, 20, or 30 years from now.
Limit test
The UK – the world’s sixth-largest economy – offers a cautionary tale about how bad things can get when investors reject a government’s borrowing plan.
In September 2022, the pound and British government bonds sold off sharply, partly in response to plans by former Prime Minister Liz Truss to issue more debt in order to pay for tax cuts. Mortgage rates and other borrowing costs have risen as investors demand much higher premiums for holding UK debt.
The Bank of England was eventually forced to step in and pledge to buy government bonds “in any volume necessary.”
Dave Ramsden, a senior central bank official, said at the time: “If the imbalance in this market persists or worsens, there will be a material risk to financial stability in the UK… This would lead to… a reduction in the flow of credit to… The real economy.”
Although central banks are able to provide temporary emergency support, they are unable to finance government deficits in place of bond investors.
Just ask crisis-ridden Argentina, where the central bank for years printed pesos to help the country’s profligate government keep paying interest on its debt and avoid default. This tactic caused the value of the currency to fall and prices to skyrocket. The annual inflation rate exceeded 211% last month, its highest level in three decades.
An election year fraught with danger
Government budgets will face renewed scrutiny this year from investors who are on high alert toward politicians who tend to make promises in an attempt to win over voters.
Half of the world’s population goes to the polls. This series of elections means little incentive for belt-tightening between existing administrations, while also increasing the likelihood that new leaders will seek to make their mark with new tax and spending plans.
Indeed, debt has become a major issue in this year’s US elections, which are set to culminate in the presidential election in November. Record levels of public borrowing have become a major point of contention between Republicans and Democrats, exacerbating standoffs over the national budget that periodically threaten to starve federal agencies of funds and prevent them from operating.
Rising debt and political brinksmanship have already affected America’s credit rating, which typically affects borrowing costs for the government, businesses and households.
Fitch lowered its rating on US sovereign debt to AA+ from the highest grade of AAA last August, citing political polarization as a factor in its decision. On the other hand, in November, Moody’s warned that it may also remove the last remaining rating for the United States from the three major rating agencies.
“One of the key elements that underpins a country’s credibility in terms of its ability to repay (debt) is political consensus,” said Raghuram Rajan, former governor of the Reserve Bank of India.
He added: “It is not inconceivable that if democracy declines in the United States, and if there is a feeling that there will be a political catastrophe,” the value of US sovereign bonds will decline. This would increase government borrowing costs.
Artificial intelligence to the rescue?
Even if the worst-case scenario is avoided, the rising cost of debt servicing following the recent rapid rise in official interest rates is draining ever-larger amounts of money away from vital public services – and making it more difficult to address the climate crisis.
According to reports in the British media, Britain’s main opposition Labor Party has scaled back some of its massive green spending plans due to concerns about increasing the country’s debt burden.
In the current fiscal year, which ends April 5, the UK government is expected to spend more on debt interest (£94 billion, or $120 billion) than it does on education or defence, according to the Office for Budget Responsibility, a financial watchdog.
In the United States, interest costs on a common measure rose to $659 billion in fiscal year 2023, which ended on September 30, according to the Treasury Department. This is 39% more than the previous year and about double what it was in fiscal 2020.
In 2023, the government spent more to service its debt than it did on housing, transportation and higher education, according to the Committee for a Responsible Federal Budget.
The surge in advanced economies’ debt, partly explained by huge interest payments, coincides with slowing economic growth and a rising number of older people relative to working-age people. Against this background, it is unclear how the world will dig itself out of its debt hole.
“What could save us relatively painlessly is to have massive improvements in productivity without losing jobs,” Rajan, now a professor of finance at the University of Chicago Booth School of Business, told CNN, suggesting that artificial intelligence could hold the key.
In fact, many experts believe that an AI-powered productivity boom could transform the fortunes of the global economy.
Let’s hope that over the next few days in Switzerland they will tell us how to do that.
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