The World Is $277 Trillion in Debt So Why Aren't Economists More Worried?

The global economy owes itself nearly four times its annual output and warnings of a "debt bubble" follow record bailouts, record spending promises and we're in the middle of a global recession deeper than ever before. But economists are keeping calm, carrying on and using war analogies to assure the public that everything will be ok.

It wasn't too long ago when austerity and cutting public spending was the only game in town. We would "fix the roof while the sun was shining" and promote economic growth by cutting debt levels, with global leaders clear that if borrowing was too high, the consequences would be severe.

"The latest research suggests that once debt reaches more than about 90 percent of GDP the risks of a large negative impact on long-term growth become highly significant," then soon-to-be British Chancellor George Osborne said in 2010, saying that the U.K. was "forecast to break through 90 percent of GDP in just two years time."

The world is now suffering the "attack of the debt tsunami", according to the International Institute of Finance (IIF). Globally, it expects global debt to hit $277 trillion by the end of 2020, working out as 365 percent of global GDP. That's just over four times the value that worried policymakers a decade ago. There have been enough "unprecedented" events already in 2020 but this is another one, with debt never having been higher as a total number and not higher as a percentage since the aftermath of World War II.

There are now few Western economies with debt below this "dreaded" 90 percent. The U.S.'s debt-to-GDP ratio stands at just under 97 percent, The U.K.'s at around 102 percent, Italy at 158 percent and Greece at 213 percent. There are a number of exceptions in the West - Germany, Australia and The Netherlands being the major ones - but they are exceptions.

British Chancellor Rishi Sunak is delivering a spending review where he is expected to outline further government increases in spending while trying to cut anything seen as not vital to the U.K.'s long-term prosperity. British debt has just crossed over £2 trillion ($2.7 trillion) for the first time and is likely to increase while COVID restrictions remain. Despite the fact debt has increased from around £1.2 trillion ($1.6trillion) in 2010, Sunak will not be returning to the "austerity" rhetoric of Osborne a decade ago.

"Governments should accelerate spending pretty much at any cost"

While austerity was nothing new, the 90 percent figure came from Prof. Carmen M. Reinhart, now chief economist and vice president at the World Bank, and Prof. Kenneth Rogoff, a Harvard University economist and chess Grandmaster. In a widely shared Harvard paper in 2010, they argued that "median growth rates for countries with public debt over roughly 90 percent of GDP are about one percent lower than otherwise; average (mean) growth rates are several percent lower." Essentially, if a country's debt is too high, it makes economic growth more difficult, they argued.

"The numbers behind that [Harvard research] were found not to be correct," Ian Stewart, chief economist at Deloitte UK, tells Newsweek. "I don't really know what the 'right' ratio is. Japan's ratio is over 200 percent. I'm not advocating that but they've been able to live with it.

"The debt is a manageable problem. That's not to say there are significant risks associated with the accumulation of debt - the most obvious being governments seeking to reduce the real burden of debt by inflating it away or defaulting on their debts or you have a debt crisis requiring significant austerity - but financing costs are vanishingly low."

The Harvard research was picked apart by a graduate student in 2013 at a similar time as then European Union commissioner Olli Rehn and Republican Paul Ryan were both quoting the 90 percent debt-to-GDP limit to support their austerity strategies. There were a number of omissions and inconsistencies in the data which Reinhart and Rogoff addressed in a New York Times op-ed, saying "there is no rule that applies across all times and places ... Nowhere did we assert that 90 percent was a magic threshold that transforms outcomes, as conservative politicians have suggested."

Trader at the NYSE
Trading on Wall Street was halted immediately after the opening bell in March as stocks posted steep losses following emergency moves by the Federal Reserve to try to avert a recession due to the coronavirus pandemic JOHANNES EISELE/Getty

The research has been widely discredited but the view behind it was not a new one. In the 1970s, then-British Prime Minister James Callaghan gave a speech saying that "spend[ing] your way out of a recession and increas[ing] employment by cutting taxes and boosting government spending" was not a sensible one and would lead to high inflation.

Are we in an age where this view has been discredited so far that a modern version of Keynesianism, the theory of high spending to promote growth, is now something practiced by most developed economies while they sustain debt-to-GDP ratios above 100 percent?

"It's not useful to think of debt as good or bad," economist Ethan Ilzetzki, an associate professor at the London School of Economics (LSE), tells Newsweek. "Debt serves the purpose of allowing countries and people the chance to do things at a time of their choosing rather than when the income comes in. This is exactly the sort of time public debt is designed for - war, pandemics, massive recessions.

"Governments should accelerate spending pretty much at any cost, given the current circumstances because of the depth of the recession we're facing and worry about the consequences later on."

These direct consequences are difficult to pin down. But one possibility is an increase in diplomatic tension within the European Union and specifically within the eurozone of countries sharing the euro currency. Debt in Greece and Italy is particularly high and Greece has already been through a number of bailouts from both the International Monetary Fund (IMF) and the eurozone economies. This predates COVID but the current situation has placed increased pressure on countries.

"People have been asking for a long time about Greece," Sir Kim Darroch, former U.K. permanent representative to the EU and former U.S. ambassador, tells Newsweek. "In one sense, that seems to have gone away but the question still remains: how is Greece ever going to pay that debt back?

"The growth in southern European economies like Spain, Portugal and Italy still looks pretty anemic and you have to wonder at those set of economic challenges. Then you've got the set of political challenges, like in Hungary and Poland, so there are some deep stresses in the EU."

The link between the rise of populism or far-right parties and depression is one written through the history books - Nazism rose to prominence because of the Great Depression, the rise of Marine Le Pen in France and the election of Polish President Andrzej Duda are seen as a direct result of the 2008 financial crisis. This is something leaders are keen to avoid this time around.

Within COVID, EU leaders agreed a €750 billion ($890 billion) to provide grants and loans to countries worst affected by the pandemic. This effectively means EU budgets double for at least three years.

"The decision taken about the huge rescue package with a lot of German money in it crossed some hitherto inviolable red lines with how much they're putting into it," Sir Kim says. "They've [the Germans] been opposed to resource transfer to poorer countries in the EU but this resource package looks like a big step towards that. It's maybe [Chancellor Angela] Merkel's last big act of statesmanship.

"If there's a decade now of low growth, it will put immense strain on those relationships. If you look at the technical challenges of leaving the euro and restarting your own economy, it's massive, almost impossible so maybe there is no way out. I'm confident that the EU will hold together."

The real truth is that so much of this debt "tsunami" is political. If the world is $277 trillion in debt then the world is also $277 trillion in credit. That money is owed to somebody so, while it is a lot more complicated in practice, it is literally a zero-sum game if not a metaphorical or political one.

For example, China borrowed $6.2 billion from the World Bank between 2016 and 2018 but loaned more than $700 billion to other countries. This makes it the world's largest official creditor, bigger than the World Bank and the IMF, and it's as much about politics as it is about cash. On a smaller scale, president-elect Biden is looking at erasing student debt, a hitherto seemingly impossible policy suggestion. In these "unprecedented" times, "unprecedented" decisions are being made about spending. And it is clear that there will be some winners and losers both politically and financially, particularly in Europe. But if one population wins, does another have to lose?

"[The Greek bailout] is more in the realm of politics than it is in economics," Prof. Ilzetzki says. "The eurozone as a whole can foot the Greek fiscal bill pretty easily. But there's a big problem institutionally if the eurozone explicitly tries to do that.

"Because of the size of Greece, it's about how much the German or French taxpayer is willing to tolerate. The bigger concern is if things go south in Italy. Now we're talking about real money and a true economic problem as opposed to a political one. Other eurozone members would have to make real and substantial economic sacrifices to bail out Italy and then it's a true trade-off - whether it's something that's feasible or desirable."

Greece is around the 50th largest economy in the world. Italy is the eighth largest by nominal GDP. "The Italian economy is facing one of its darkest hours in modern history," Maartje Wijffelaars, a senior economist at RaboResearch, wrote. She said that the government would not be able to prevent an increase in corporate defaults and the picture for Italian banks "remains gloomy".

A worst-case scenario sees Italy failing to recover as quickly as its European counterparts, debt quickly increasing and, as the economy falters, a rise in right-wing Euroskeptic politicians before an election in 2023. That would complicate European loan agreements further and risk falling into the historical precedents set by Germany, Poland and others.

"It's impossible to pin an exact number to that [of how likely it is to happen]," Prof. Ilzetzki says. "At the moment, I see no major reason for concern. Italy has the advantage that much of its debt is held domestically in its pension system and its own banking system. That has its own risks but it at least shelters it from any market panic on its debt. But there could be surprises there are as anywhere else. I wouldn't put it as a high probability but those would be the major risks I'd be looking at."

A lot rests on just how quickly the world's biggest economies recover from COVID if, or now more likely when, a vaccine is rolled out in 2021. The letters representing the shape of economic recovery - W, V, L, U or anything else - are vital to debt levels because the more quickly an economy grows, the smaller the debt is in comparison.

"When you're in a war, as we were in World War I and World War II, you worry about winning the war and then you worry about how you're going to pay down the debt"

"On our models, it takes the economy the best part of two years from now to recover the level of activities it had before the crisis," Stewart says. "If you're looking at levels of GDP, it's not a quick snap-back. That's much better than the damage caused by the [2008] financial crisis, which lasted about five years before the economy regained its former levels.

"There is no one 'bad' debt number but there are things that get you worried - if you're not issuing debt in your own currency, if bond markets are starting to price greater risk from you as an issuer, if you had a history of default - but it's better to think of this as a spectrum. This is a textbook case of where debt spending was needed but will differ by country."

One of the key reasons that economists are not worried is that interest rates are at historic lows. In Germany, the government is actually borrowing at negative interest rates so it will be paying back less than it borrowed. Long-term trends show a decline in interest rates and most believe that low rates are here for a while. This gives governments time to develop a solution to balancing the economy.

"The happiest way to balance this is to engineer a strong and sustainable recovery," Walker says. "This does happen and there are situations where debt is reduced more quickly than expected. The golden scenario is very strong growth but the reality is that it's going to be a combination of, for most countries, growth, tax rises, cuts in public spending and, possibly, accommodating significantly higher levels of debt compared to GDP for quite some time."

This higher level of debt is still going to be $277 trillion and rising. Even before COVID, around 40 percent of low-income countries were at risk of debt distress and the world has become more indebted than ever before, and at a pace not seen in peacetime.

"It's easy to turn this number into something that is scary and there are reasons to be concerned but we should look specifically look at people's ability to pay back rather than numbers in aggregate," Prof Ilzetzki says.

"The U.K. economy has 100 percent GDP and will be higher in the future. The U.S. has similar and if that debt was recalled at once, those countries would have to give their entire output that year to creditors. That's a too-simple way of looking at it and would be impossible to happen because of the agreements in place."

And perhaps the most telling voice about this whole thing is back where we started the financial crisis and the decade of austerity that followed - with Professor Reinhart herself:

"First and foremost, when you're in a war, as we were in World War I and World War II, you worry about winning the war and then you worry about how you're going to pay down the debt," she told The Harvard Gazette. "I think that analogue applies here. You do what you have to do to win the war, and then you worry about that. In the out-years, we will be doing a lot of worrying."

How much of the $277 trillion is worth worrying about remains to be seen. As long as interest rates remain low and long-term strategies are implemented, economists are not panicking yet but, as Prof Ilzetzki says, "it's really hard to predict the exact moment appetite for lending shifts and that can happen pretty abruptly."