Archive for category: #Finance
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- A full-blown recession and credit crunch could spur an 8% corporate default rate, BofA estimated.
- That would put nearly $1 trillion of existing corporate debt in distress, the bank said in a note.
- Investors have been worried about a recession as high rates and tighter credit squeeze the economy.
The impact of a recession and a credit crunch could be that $1 trillion worth of corporate debt ends up defaulting, Bank of America credit strategists said in a note.
“It has been a long time since we had a proper credit cycle,” Oleg Melentyev wrote to clients on Friday, pointing to the credit cycles beginning in 1981, 2000, and 2007. Those cycles were upended by a dramatic tightening of credit conditions, leading the three-year default rate on US corporate default debt to soar to around 15%.
Melentyev said that a 15% default rate on corporate debt was a “distinct risk” as the US approaches a recession and credit gets tighter, though he believed a coming credit crunch will likely be less severe than what was seen during the Great Financial Crisis.
“We think it is reasonable to argue that that the next-3yr default cycle, whenever it starts, should add up to a lower peak,” he said. That would still amount to an 8% corporate default default rate in a full-blown recession, which could translate into $920 billion of corporate debt defaults.
That’s largely because banks have already started to pull back on credit conditions since the collapse of Silicon Valley Bank. US debt growth has also pulled back in recent years, and a “full-scale” recession hasn’t been officially declared yet, though Bank of America strategists have said a mild downturn could start this quarter.
“If a full-scale recession doesn’t arrive in the next year or two, the cycle will get delayed, but not canceled. For now, we continue to think that a mild/short recession is a more likely outcome than a full-scale one for the foreseeable future. Therefore, we assume a moderate pace of loss-gathering is already underway, but it has not yet reached a point of a lift-off to take us to 8% aggregate across all credit,” he added.
Markets are growing jittery over the prospect of a future downturn, with the New York Fed’s US Recession Probability Index predicting a 68% chance that a recession will arrive by April 2024. The risk stems from the Fed aggressively raising interest rates over the past year to tame inflation.
That risk has been amplified with recent banking turmoil, as lenders weather losses on their bond portfolios and steep deposit flight, causing them to tighten up on new lending.
- Commercial real estate lending more than halved last quarter compared to the prior year.
- The MBA attributed the drop to a “logjam” of uncertainty that’s freezing the market.
- Demand for office and apartment buildings has faltered, and high interest rates continue to weigh on the sector.
Commercial real estate lending more than halved last quarter, thanks to the “logjam” of uncertainty that’s clogging the market, the Mortgage Bankers Association said on Tuesday.
In the first quarter, commercial real estate mortgage loans plunged 56% compared to a year ago, and loans dropped 42% from the fourth quarter.
Though lending activity typically dies down in the first quarter of the year, the latest figure marks the slowest pace since 2014, the MBA said.
“Uncertainty and volatility in regards to interest rates and property values, and supply demand imbalances for some property types, has led to a logjam in commercial real estate sales and financing markets,” MBA’s head of commercial real estate research Jamie Woodwell said in a statement.
Experts have been warning of trouble ahead in the commercial real estate market for months, due to a higher cost of borrowing and faltering demand for office buildings as work-from-home trends persist. Apartment buildings, which are typically grouped in with commercial real estate, have also suffered a drop in demand, with sales posting their largest drop since the 2008 financial crisis.
That’s been exacerbated by recent banking turmoil. Small- to mid-sized regional lenders finance around 70% of all debt in the commercial real estate space, according to Bank of America, and banks will likely pull back on lending as they reassess the huge holes left in their balance sheets.
Meanwhile, there’s nearly $450 billion in commercial real estate loans that’s set to mature in 2023 and will need to be renegotiated. JPMorgan estimated around 20% of commercial real estate loans could default.
“As loans mature and adjustable-rate loans reset, we should start to get greater insights into where things stand,” Woodwell said.
Academic Study Finds that One of the Four Largest U.S. Banks Could Be at Risk of a Bank Run
By Pam Martens and Russ Martens: May 9, 2023 ~ The systemic threats to the U.S. financial system were not remedied when Congress passed the watered-down Dodd-Frank financial reform legislation in 2010. While that has been evident with each Federal Reserve bailout of the mega banks and their derivative counterparties, the threat has now gained increased urgency for Congress to confront as a result of a new academic study. A team of four highly-credentialed academics at four separate universities present compelling evidence that one of the four largest U.S. banks, with “assets above $1 trillion,” could be at risk of a bank run. The study is titled: “Monetary Tightening and U.S. Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs?” Its authors are Erica Jiang, Assistant Professor of Finance and Business Economics at USC Marshall School of Business; Gregor Matvos, Chair in Finance at the Kellogg School of Management, Northwestern … Continue reading →
Deposits at JPMorgan Chase, Bank of America and Wells Fargo Shrank by $465 Billion Y-O-Y; More than Twice the Total of 4,000 Small Banks
By Pam Martens and Russ Martens: May 8, 2023 ~ Since the banking crisis began making headlines at expensive media real estate, the narrative has been that deposits are fleeing the small commercial banks and flooding into the biggest banks that are perceived as too-big-to-fail and thus offer a safer venue for deposits. Because these mega banks are the same ones that the Fed has been bailing out since the financial crisis of 2008, that narrative requires believing that our fellow Americans are dumber than a stump. We decided to check out that narrative for ourselves. Not only is that scenario wrong, but it is so decidedly wrong, and it’s so easy to get the accurate figures, that from where we sit it looks like there might have been an agenda by someone to harm smaller banks. (Since it’s short sellers who have benefited to the tune of more than $7 … Continue reading →
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- The US could run out of money to pay its obligations as soon as June 1, as the debt ceiling looms.
- The White House is warning that a protracted default could be as bad as the Great Recession.
- However, unlike in previous recessions, the government couldn’t cushion the blow during a default.
The White House is sounding the alarm about what economic horrors the country might see without action on the debt ceiling.
An analysis from the White House Council of Economic Advisers probes what a default on the nation’s debt might look like. It would be an unprecedented economic catastrophe, and one that Treasury Secretary Janet Yellen warns could happen as soon as June 1.
If there’s a short default, the US would shed half a million jobs, and unemployment would increase by 0.3%, according to CEA’s analysis. And, in the worst case scenario — a protracted default — the country would lose 8.3 million jobs, and unemployment would rise by 5%.
That protracted default would trigger an “an immediate, sharp recession on the order of the Great Recession” of 2008-2009, according to CEA. The stock market would plunge by 45% in just the third quarter of 2023, making a dent on retirement accounts and leaving people spending less.
But there’d be a big difference from previous downturns: Unlike the Great Recession or the short but deep recession caused by the Covid pandemic, the government won’t be able to step in and throw money at the economic wounds. That’s because it wouldn’t have any.
To prevent a default within the next weeks or months, Congress will have to act within its limited number of working days to strike a deal — something that still looks far off as Republicans narrowly passed a bill full of spending cuts that Democrats pronounced dead on arrival.
“I think there is a path forward,” Mark Zandi, the chief economist at Moody’s Analytics, told Insider. “I think they should suspend the debt limit until the end of the fiscal year, and then pass legislation at that time to increase the debt limit, hopefully for at least a couple years.”
“I think people should understand that it is highly likely we will come to a deal. However, it’s worth being aware that if we do go over the debt limit cliff, the effects on families, corporations, the financial sector, and the economy could be potentially devastating,” Brian Riedl, a senior fellow and economist at the conservative-leaning Manhattan Institute, told Insider. “About roughly 20% of federal spending would have to be eliminated immediately. Federal contractors would not be paid, which could bring furloughs, layoffs, bankruptcies to tens of thousands of businesses.”
The clock is ticking
Zandi said that his most likely projected X-date — the deadline for when the government will no longer be able to pay its bills —is June 8, and the best-case scenario would be August 8.
Even though Speaker of the House Kevin McCarthy’s bill passed the House last week, it faces a highly likely rejection in the Democratic-controlled Senate and White House. Biden also vowed to veto the bill should it make it to his desk.
But that leaves the House with just 12 legislative days left to come to agree on a solution to raise the debt ceiling — and neither side is appearing to budge on their stances. Biden is meeting with McCarthy, Senate Majority Leader Chuck Schumer, Senate Minority Leader Mitch McConnell, and House Minority Leader Hakeem Jeffries on May 9, and a White House official previously indicated to Insider that Biden will stick with his belief that raising the debt ceiling should be bipartisan, without any spending cuts attached.
Democratic lawmakers have been sounding the alarm on the consequences of Republicans’ proposed spending cuts. Massachusetts Sen. Elizabeth Warren, for example, previously cited an estimate from Moody’s Analytics that found that even if the GOP bill to raise the debt ceiling managed to get signed into law, it would cost Americans 2.6 million jobs and trigger a recession in 2024.
“Republican-imposed austerity would mean the U.S. economy in 2033 would still be short nearly 1 million jobs and 3 percentage points of GDP growth – as if our economy stood completely still for a year,” Warren wrote in a letter to Biden. “In fact, the economic impact would be so great, that it would result in even more job losses than a short-lived debt ceiling breach, in both the short- and long-term.”
A trillion-dollar coin?
As Insider previously reported, there are some options on the table to avert a debt ceiling crisis while avoiding congressional drama. The Treasury could mint a $1 trillion platinum coin — a loophole that would allow Yellen to deposit the coin in the Federal Reserve and continue paying the government’s bills. Another option would be invoking a clause in the 14th amendment that would declare the debt ceiling unconstitutional.
But Yellen has previously dismissed both of those routes, and the Biden administration is not budging on a clean debt ceiling increase to stave off economic catastrophe in as soon as a month.
“We’re not going to entertain scenarios where Congress compromises the full credit — the full faith and credit of the United States,” White House Press Secretary Karine Jean-Pierre said during a Wednesday press briefing.
“We’ve been very clear from here, the President has been very clear that Congress must act. This is their constitutional duty to act,” she said. “And we must avoid catastrophic threats to our economy. That needs to happen.”
Giant asset managers like BlackRock and Vanguard are increasingly but imperceptibly becoming owners of more and more aspects of our lives, from housing to roads to energy infrastructure.
Asset management companies play an increasingly important role in controlling the infrastructure within which our daily lives are embedded. (saulgranda / Getty Images)
Apartment complexes, water pipes, schools, and toll roads; fossil fuels and clean energy infrastructure. Across the world, these resources are moving into the hands of nearly invisible entities: asset managers, such as BlackRock, Vanguard, and State Street. Over the past few decades, these often-forgotten administrators of retirement accounts have branched out from investing in financial assets like stocks and bonds to owning some of the most basic infrastructure of our daily lives.
In Our Lives in Their Portfolios: Why Asset Managers Own the World, political economist and economic geographer Brett Christophers traces the history of asset management from its beginnings to its dominant present and exposes the industry’s current grip not just on financial markets but on the building blocks of life. By spotlighting the invisible owners of our homes and our roads, our water pipes and our schools, Christophers reveals the consequences of asset managers’ profit-seeking control over our fundamental resources.
Cal Turner and Sara Van Horn spoke with Christophers for Jacobin about how asset managers came to occupy such a powerful position in the global market, what their growing hold over essential resources means for our collective futures, and who really profits from high-investment returns.
- Cal Turner
What exactly is asset management? What is an “asset manager society”?
- Brett Christophers
Asset managers are companies that carry out investment on behalf of others. Principally, they carry out that investment on behalf of institutional investors, like pension schemes and insurance companies. But they also carry out investment on behalf of so-called retail investors, which are the likes of you and me. Asset management is a broad industry of which things like private equity, hedge funds, and index funds are component parts.
“Asset manager society” is a term I use to signal a transformation that has occurred over the past thirty years. The origins of the modern asset management industry are in the 1960s and ’70s, principally in the United States. When asset managers began to invest on behalf of pension funds, they invested exclusively in financial assets: stocks and bonds, including bonds issued by governments and municipalities.
At one level, who owns shares in Microsoft or government debt does matter to society at large, but it matters in quite a distant way. To you and me, it makes no difference at all to our daily lives whether that investment is carried out by our pension fund trustee directly or indirectly via an asset manager. What asset managers did was far removed from everyday life for a long period of time.
But in the 1980s, asset managers began to diversify their holdings into what are typically referred to as “real assets.” Instead of just investing in financial assets, they began to buy physical things, rather than just share certificates or digital numbers on the screen. In particular, they began to buy commercial property: offices, hotels, shopping centers. In the 1990s, they began to diversify into new types of real assets. Asset management companies began to buy housing, particularly apartment blocks, and they began to buy infrastructure — including essential infrastructure in energy, transportation, and water supply.
An asset manager society is a society in which asset managers play an increasingly important role in controlling the infrastructure within which our daily lives are embedded.
These asset managers began to play a very significant role shaping the conditions and the costs of people’s everyday lives, because they were now buying, owning, controlling, and earning money from the physical things on which we all rely — whether that’s housing, the electricity grids that supply our power, the municipal systems of pipes that supply water to homes, or the parking systems where we park our cars. An asset manager society is a society in which asset managers, which are often faceless financial institutions that most people don’t know about, play an increasingly important role in controlling the infrastructure within which our daily lives are embedded.
- Sara Van Horn
How does asset management impact housing, both as a market force and for those who need it?
- Brett Christophers
Asset managers regard housing as an asset: something that will deliver a recurring income, which is the rent that the tenant will pay, and that will also deliver a capital gain when it comes to selling that asset at a later point. Given that those are their underlying motivations, what are they looking for when they invest in housing? What they’re looking for is the capacity to increase the rents that they are able to extract from that property.
That’s the case for two reasons. One is that more rent means more income to be pocketed, but much more important than that is that higher rent makes the asset more valuable to prospective buyers at a later point in time. The key thing to remember about asset managers is that they are largely not in the business of buying and holding assets into perpetuity. They are in the business of buying and selling assets. When they buy assets, their primary consideration becomes how best to manage that asset in such a way that it becomes more valuable to the market. Increasing rents is obviously the primary way for them to do that in terms of housing.
Over the last decade or so, the most common strategy that asset managers have pursued in buying rental housing is buying in areas where there are very tight rental markets, where there are essentially not enough rental properties to meet demand. There’s an obvious reason for that: in such rental markets, there tends to be upward pressure on rents. Just as important, if not more important, they look to buy in places where they think there is only a limited prospect of substantially more rental housing being built, because that would represent a clear and present threat to their business model.
The reason I emphasize this is that what they do runs almost diametrically counter to what they say their interests are in housing markets. When they talk to politicians, when the media asks them, “What are you going to do about the housing crisis, about the fact there are shortages of supply and the fact that renters can’t afford their rents?”, what these asset managers typically say is, “We’re part of the solution; we want to add to new supply.” It’s really not true — that is absolutely not what they’re interested in. And if you listen to other conversations that they have, when they talk to investors on earnings calls, they say the complete opposite: “We’re investing in places where there are supply shortages, because that gives us the pricing power that we like in those markets.” They say two completely different things to two different constituencies. And what they say to investors is much more truthful.
There’s also an inherent short-termism in this behavior, because the asset manager knows that he or she has to sell these assets pretty soon after buying them. That inherent short-termism is really inappropriate and destructive when it comes to assets like housing, water supply networks, and electricity transmission grids. Asset managers are inappropriate custodians of these types of assets. They’re about as inappropriate as you can imagine.
- Cal Turner
You write that energy — especially renewable energy — is the largest sector for asset managers investing in infrastructure, and that asset managers also have stakes in other climate infrastructure, such as transportation. What does this mean for our energy future and our climate more broadly?
- Brett Christophers
What most people have looked at when they think about climate and asset managers is the dirty side of the equation. They look at the fact that asset managers remain substantially invested in fossil fuel companies and many of the other corporations that continue to be responsible for large amounts of emissions.
One of the main reasons for that is that the biggest fund managers, like BlackRock, Vanguard, Fidelity, and State Street, are predominantly passive managers: their biggest funds track particular market indices. If you have a fund that’s tracking the S&P and that index includes Exxon Mobil and Chevron or, in the European context, BP, Shell, and Total, then you are required by the nature of your fund to remain invested in those assets. The big asset managers, by virtue of the nature of their model, remain major owners of fossil fuel companies and other huge emitters. A lot of the attention that both scholars and activists have focused on the climate finance question is focused on asset managers as owners of dirty assets.
Asset managers’ inherent short-termism is really inappropriate and destructive when it comes to assets like housing, water supply networks, and electricity transmission grids.
In my work, I tend to focus on the other side of the question, which is asset managers as owners of clean assets — the assets that are being constructed to try to get humanity out of the crisis. The biggest area of interest is clean energy assets. If you look at the ownership of the infrastructure of clean energy generation, and, in particular, if you look at it relative to the infrastructure of dirty energy generation, you find that clean energy infrastructure is far more concentrated in private hands than in publicly owned infrastructure. Something like 50 percent of fossil fuel assets are owned by the state, either directly or indirectly through state-owned companies. The number is nowhere near that with clean energy infrastructure, which is something like 90 percent private.
As we move through the energy transition, we appear to be moving toward a more privatized system of infrastructure ownership, simply by virtue of the fact that clean energy infrastructure historically has been generally invested in by private companies. To be more specific, increasingly, the biggest investors in clean energy infrastructure are asset managers.
For example, Brookfield Asset Management, which is a Canadian company, and one of the main companies I talk about in the book, is one of the world’s largest owners of renewable energy infrastructures. BlackRock is increasingly becoming a major owner of these infrastructures. When the executives at companies like BlackRock talk to policy makers about climate questions, they talk to them not just about the dirty side of the equation, but about the clean energy side of the equation.
Asset managers were some of the biggest lobbyists and interested parties behind the Inflation Reduction Act last year, which was about providing incentives for further private investment in US clean energy infrastructure. The ten-year extension of subsidies that have been put in place by the Inflation Reduction Act is one that asset managers actively lobbied for, and they have subsequently spoken about how enthused they are by those incentives. To the extent that the climate crisis is an infrastructure crisis, it’s about asset managers, because asset managers are increasingly becoming the biggest investors and owners of infrastructures of all types, including climate infrastructure.
To the extent that the climate crisis is an infrastructure crisis, it’s about asset managers, because asset managers are increasingly becoming the biggest investors and owners of infrastructures of all types.
- Sara Van Horn
You describe how ownership by asset managers is usually invisible, even as it directly affects very concrete aspects of our daily lives. You call this a “very physical if also strangely intangible” type of ownership. Can you talk about the effects of this invisibility?
- Brett Christophers
Asset managers increasingly own very important forms of infrastructure that really affect our lives — yet most people are not aware that asset managers own those infrastructures. They probably wouldn’t recognize the names of most of these companies.
If Brookfield Asset Management is the ultimate owner of the apartment block in which you live, you almost certainly wouldn’t know that. Typically, there’ll be a local holding company, an intermediary, that is actually registered as the apartment owner. The name Brookfield wouldn’t be visible. Even if it was registered as the owner, it wouldn’t be Brookfield that you interacted with as a tenant in terms of who carries out the maintenance and deals with you if you’re late with rental payments.
A lot of the day-to-day drudge work of managing these various types of housing and infrastructure assets is not carried out by the asset manager, or even by a company that the asset manager owns: that work gets contracted out. Macquarie Infrastructure and Real Assets, which is, alongside Brookfield, the world’s biggest asset manager in terms of infrastructure ownership, estimates that around one hundred million people rely every day on infrastructures that it owns around the world. Yet I’d wager that at most a couple of thousand people out of those one hundred million know that they’re using infrastructures that Macquarie is the ultimate owner of.
What are the consequences of that invisibility? The main one is that they become very distant from potential critique. For people struggling with bad living conditions and rapidly increasing rents, or burst water pipes and increased water rates, it’s very difficult to take issue with the asset management companies, who are the ultimate owners of these assets, if people don’t know that they are indeed the owners. It becomes a very depoliticizing structural configuration. A lot of activists have been dealing with these questions to try to render visible what was previously invisible.
- Cal Turner
Despite the general invisibility of asset managers, some have recently come under fire for their holdings in industries like fossil fuels. When asset managers are challenged over the impacts of their investments, how do they justify their choices?
- Brett Christophers
One of the arguments that asset managers often make about what they do is that, at the end of the day, it’s in your interest as an ordinary citizen for our funds to perform well. If our funds perform well, then your retirement savings will increase, so if you’re going to criticize us, it’s you who will be hurt.
That’s a discourse that lots of people get persuaded by. But it’s also a misleading discourse, for a couple of reasons. It’s certainly the case that a lot of the money that is invested in housing and infrastructure by asset managers is, indeed, retirement savings. But it would be disingenuous to argue that those retirement savings are principally the savings of ordinary workers. Retirement savings represent a form of wealth that, like all forms of wealth, is unequally distributed among the population. In the United States, something like 50 percent of all retirement savings are held by the top earnings quintiles among workers, while the lowest earnings quintile essentially has no retirement savings.
When asset managers’ funds perform well, there are end investors who in turn also do well. But to suggest that they are predominantly ordinary workers is very far from the truth.
To argue that if an asset management fund performs well, then ordinary workers benefit by virtue of growth in their retirement savings is simply not true. Most of the retirement savings that are invested are the retirement savings of wealthy people, not ordinary workers. They’re the pension pots of consultants, doctors, bankers, and executives, including of course the executives of asset management companies themselves.
The second thing is that, yes, pension schemes are very significant contributors to these real estate and infrastructure funds. But increasingly, they’re not the only ones. A growing amount of the money that is invested in these funds is coming from sources around which it would be much harder for asset managers to tell a comforting public relations story.
A few years ago, for example, Blackstone established a huge new infrastructure fund, and around 50 percent of the capital that is committed to that fund is provided not by pension schemes and underlying workers’ retirement savings, but by the sovereign wealth fund of Saudi Arabia, which is an entity that has received a huge amount of scrutiny and criticism from human rights organizations like Amnesty International. A minority of the money in that fund represents retirement savings, and a minority of those retirement savings represents the money of ordinary workers. When asset managers’ funds perform well, there are end investors who in turn also do well. But to suggest that they are predominantly ordinary workers is very far from the truth.
Banks that Put Up $30 Billion to “Rescue” First Republic May Have Been Trying to Rescue their Own Exposure to $247 Trillion in Derivatives
By Pam Martens and Russ Martens: April 27, 2023 ~ Ever since 11 banks on March 16 donned the garb of heroic fire fighters, rushing to extinguish an inferno at a competitor bank before it spread further, we have been asking ourselves the question – why just this group of 11 banks. We’re talking about the action on March 16 when 11 banks chipped in a total of $30 billion and bizarrely placed those funds as uninsured deposits into First Republic Bank – which was in full scale unraveling mode because of bond losses and – wait for it – too many uninsured deposits. Four banks contributed two-thirds of the total deposits with JPMorgan Chase, Bank of America, Citigroup and Wells Fargo ponying up $5 billion each. Morgan Stanley and Goldman Sachs deposited $2.5 billion each; while BNY Mellon, State Street, PNC Bank, Truist and U.S. Bank each deposited $1 billion, … Continue reading →
- Larry McDonald has warned carefree tech investors are “smoking in the dynamite shed.”
- The founder of “The Bear Traps Report” expects further banking turmoil to tank the stock market.
- The former Lehman Brothers trader cautioned last month that stocks could plunge 30% by May.
Tech-stock bulls are at high risk of blowing up as mounting pressures on US banks threaten to crash the equity market, Larry McDonald has warned.
“A lot of these people are smoking in the dynamite shed,” the founder of “The Bear Trap Report” told CNBC about the tech investors trumpeting their favorite stocks on TV.
McDonald flagged Britain’s bond-market disaster, the sudden failure of Silicon Valley Bank and Signature Bank, and UBS’ emergency takeover of Credit Suisse as signs of stress in the global financial system. Early signs of a credit crunch and ongoing turmoil in the regional-banking sector suggest there’s more trouble ahead, he said.
“This is a rolling crisis,” he declared, cautioning that the Federal Reserve’s interest-rate hikes are “draining the banking system.”
“From credit cards to all different types of companies, credit default swaps are rising on many different financial institutions,” he continued. “When you see that, be very careful with US equities.”
Credit default swaps (CDS) serve as insurance against a company defaulting on its debts, and become more expensive as the perceived risk of a default grows.
McDonald is a former Lehman Brothers trader and the author of “A Colossal Failure of Common Sense,” which chronicles how the investment bank ended up collapsing in September 2008 and sparking a global financial crisis.
He warned on March 8 that US stocks could plummet as much as 30% by early May, as higher interest rates choke the economy and frustrated investors switch out of equities into bonds. Higher rates can hinder spending by increasing borrowing costs, and they lift yields on bonds, boosting their appeal relative to stocks.
McDonald’s collection of 21 systemic risk indicators were signaling “one of the highest probabilities of a crash in the stock market looking out 60 days,” he said at the time.
Policymakers in the Global North have mostly responded to rising inflation by raising interest rates. That’s bad for their own workers — and it’s creating a debt crisis for many countries in the Global South.
Vendors sell products in a busy street in Accra, Ghana, on March 21, 2022. (Seth / Xinhua via Getty Images)
At the end of last year, Ghana defaulted on its debt as the government suspended payments on most debts owed to foreign creditors. Earlier in 2022, Sri Lanka also entered default as inflation sent the country’s currency tumbling, exacerbating the cost-of-living crisis as imports of essential goods like food and medicine became more expensive.
This year, Pakistan finds itself on the brink of default as the combination of high inflation and climate breakdown fueled environmental disasters devastated its economy. Pakistan’s situation is particularly worrying given the fact that the country is the world’s fifth largest by population. Other countries like Zambia and Lebanon have been in default for much longer.
High inflation and slow global growth have wracked many poor economies at the same time as rising interest rates have made debt servicing more expensive. Fifteen percent of poor countries are already in debt distress — when a country is unable to fullfil its financial obligations and debt restructuring is required — while half are in danger of entering it.
In short, the world economy is already in the midst of a sovereign debt crisis. The United Nations Conference on Trade and Development (UNCTAD) has warned that the developing world faces a “lost decade” as a result of the debt crisis, estimating that debt servicing alone will cost these states at least $800 billion.
There are, of course, notable differences in the economic and political situations of the countries currently in, or on the brink of, default. Ghana’s situation is unique in that much of its debt is owed to domestic rather than international creditors. Its default, therefore, risks creating a deep shock to the domestic financial sector, which would likely reverberate throughout the rest of its economy.
Sri Lanka, previously a golden child of international financial markets owing to its strong record of debt repayments, mismanaged its negotiations with creditors when the economic crisis became particularly acute. And countries like Pakistan and Lebanon, which is also on the verge of default, have suffered from decades of corruption and political mismanagement.
But while it is important not to insulate domestic elites from responsibility for the role they have played in exacerbating their countries’ debt crisis, it is also critical to recognize the global factors that are driving debt distress across the developing world — one of the most important being the way in which the rich word is dealing with its own economic crisis.
The inflationary crisis that began to tear through the world economy from last year is being driven by three main factors: the uneven recovery from the pandemic, the war in Ukraine, and — often forgotten — climate breakdown. These are not issues that can be solved by fiddling around with the cost of borrowing. And yet this has been policymakers’ central response.
By raising interest rates, central bankers hope to slow growth and investment, increasing unemployment and disciplining workers into accepting less pay. The idea is that, even though workers did not cause the crisis, they can be made to pay for it.
Yet across most of the rich world, real wages are failing to keep pace with inflation, meaning that most workers are facing pay cuts. If policymakers really wanted to curb inflation, they would focus on profits, which in many sectors have soared even as input costs have risen. As the political economist Isabella Weber has forcefully argued, many large companies have taken advantage of inflation to raise prices higher than their costs, pocketing the difference.
So, interest rate hikes won’t solve the inflationary crisis in the rich world. They will, however, make it much more expensive for poor countries to finance their debts. The monetary policy currently being pursued in the rich world has been designed to impoverish workers domestically, with the added bonus of impoverishing poor countries globally.
We have been here before. In the 1980s, when the then chair of the Federal Reserve, Paul Volcker, sent US interest rates through the roof to discipline US workers, it led to dozens of defaults in the Global South. The so-called Volcker shock laid the foundations for neoliberalism in the United States and, conveniently, it also provided the perfect pretext for imposing neoliberal policies on the Global South.
When poor countries were forced to appeal to international financial institutions for emergency lending, they received this assistance in exchange for introducing policies like privatization, deregulation, and tax cuts. The terms of these loans — referred to as structural adjustment programs — decimated many economies and permanently increased inequality in others.
Yet no lessons appear to have been learned from the debt crisis of the 1980s. As countries like Ghana and Sri Lanka have appealed to international financial institutions for assistance, they have been forced to introduce austerity policies that are likely to constrain growth for years to come.
If austerity hasn’t worked in the rich world, it’s certainly not going to work in the poor world, where significant investment in infrastructure and public services is necessary for sustainable development. In fact, forcing poor countries to cut spending at a time when vast sums of money are needed for decarbonization and climate change mitigation is likely to exacerbate both the climate crisis and global inequality.
Debt cancellation is urgently needed to deal with both the global debt crisis and the climate crisis. Rather than forcing countries to implement regressive and self-defeating austerity measures in exchange for emergency lending, new lending could be directed into investment in green infrastructure and climate mitigation — as well as protecting important carbon sinks like rainforests and tundra.
But over the long run, even debt cancellation will not be enough to close the gap between the rich and poor worlds. The reason that poor countries have been forced to take on so much new debt is that they have been kept in a position of dependence in a global economy structured to enrich the wealthy and impoverish the poor.
An extractive international financial system, regressive intellectual property rules, and enforced neoliberal policies have denied many poor countries the resources required for sustainable development.
China is, of course, the major exception to this rule. It has achieved development by ignoring the rules laid down by the Global North, protecting industry and prioritizing investment. In fact, China is now the single largest lender to many poor countries, and its attitude toward debt restructuring — influenced more by geopolitical than economic considerations — will significantly impact how this crisis is resolved.
In an optimistic scenario, poor countries would be able to take advantage of the cooling of relations between China and the West to access lending on more favorable terms. As they once did through the Non-Aligned Movement, poor states could work together to resist imperialism and achieve real debt cancellation.
In a pessimistic scenario, these countries will be caught in the middle of the new Cold War. Western lenders may refuse to negotiate with Chinese ones over how to write down the debts of poor countries, leaving these states stuck in limbo. This is exactly the situation currently faced by countries like Zambia, whose creditors have failed to come to an agreement about its debt for several years now.
One thing is for certain: the world economy can’t fully recover until the Global South debt crisis is resolved. But when it comes to debt, politics always trumps economics. What happens next will be determined by what politicians and policymakers in China and the West consider to be in their interests, rather than what is most likely to promote sustainable development.