Spiralling debt could herald the next financial crisis

Concerns are growing that another financial crisis is imminent. No less a figure than Ken Rogoff wrote last week that “the next major financial crisis may come sooner than you think”.

Rogoff, a former chief economist at the IMF, shot to fame with his 2008 book This Time is Different, co-authored with his Harvard colleague Carmen Reinhart. The sub-title of the book “eight centuries of financial folly” effectively summarises the contents.

Reinhart and Rogoff take a broad historical sweep of financial crises, and conclude that their basic cause is debt.

It is not usually that the interest payments on debt become too high to be sustainable. It is a crisis of confidence that debt has become too high to ever be repayable.

In a sentence, this is essentially the story of the global financial crisis of the late 2000s.

Such crises are rare under capitalism. Indeed, over the last 150 years, the Great Recession of the early 1930s is the only other example.

So, if they are so infrequent, why worry? Unfortunately, that is not how rare events emerge.

Until last Saturday, Chelsea had not lost by six goals since 1991. It might be another 28, or even 128, years until it happens again. But their defeat followed on from their 4-0 drubbing the previous week at Bournemouth, a club which has spent almost all its history bouncing between the third and fourth tier of English football. By their very nature, rare events do not follow regular patterns.

Rogoff’s view might seem to be supported by the slowdown which is taking place in Eurozone economies. Even Germany seems to be on the brink. One longs for a genuine English word to be able to use in place of Schadenfreude.

Most recessions, however, are most definitely not caused by financial factors. They are usually short, and simply reflect the rhythms of business confidence.

The debt data published by the august Bank of International Settlements suggest that Rogoff’s fears are not in fact well founded in terms of the advanced economies.

Household debt as a percentage of GDP in the West rose from 62 per cent in 2000 to 83 per cent in early 2008. This very sharp rise by historical standards in less than a decade represents nearly $17 trillion in terms of actual money. Corporate debt increased by around the same amount.

As a percentage of GDP, company debts peaked at around 95 during the financial crisis. By 2015 this had fallen to the mid-80s and there has since been a modest rise. But we do not see a dramatic escalation.

Households have got an even tighter grip of their finances. Their debt hit 85 per cent of GDP in 2009, but is now down to the low 70s.

The main problem is undoubtedly China. Households and companies taken together had debt levels of around 100 per cent of GDP in the mid-1990s. This has since risen almost inexorable to 250 per cent. A 6-0 defeat for the Chinese is certainly looking likely.