Hi, I’m Eve. Many commentators have pointed out that the US’s pro-bank solution to the financial crisis caused a lot of problems that have only deepened over time. One big problem (alongside not punishing bank executives) was the refusal to reduce or meaningfully restructure bad loans, and then to spend enough to offset the contractionary effects of large credit losses. Making lenders bear the costs of their poor decisions also helps lay the foundation for more caution going forward.
As readers well know, ultra-low interest rates have led to more than a decade of subpar growth, stimulating speculation rather than economic activity. As JoMo points out below, the only man with a weapon, the Fed, is trying to attribute any inflation to excess demand and counter it with higher interest rates. But as JoMo emphasizes, this is not the right approach to the shortages and supply chain disruptions caused by COVID-19 and the current sanctions. And the burden falls most heavily on poor countries, who were encouraged to borrow by international institutions when interest rates were low.
Jomo Kwame Sundaram, former United Nations Under-Secretary-General for Economic Development. Originally published in Jomo’s website
Many multilateral financial institutions have previously encouraged developing countries to borrow commercially, but not from China, who are now trapped in a debt trap with little prospect of escape.
While many multilateral financial institutions have encouraged developing countries to borrow commercially in the past, they have not done so for China, and now borrowers are stuck in a debt trap with little hope of escape.
Debt has risen and growth has fallen since 2008
The past 15 years have seen a prolonged period of global stagnation that has left some economies and people faring much worse than others.
The 2008 Global Financial Crisis and Great Recession has been exacerbated more recently by the COVID-19 pandemic, interest rate hikes led by the US Federal Reserve, and escalating geopolitical economic wars.
The Reagan administration’s tax cuts, intended to stimulate private investment, have only widened the deficit and, far from enabling a quicker recovery, are calling for further fiscal consolidation, as in the 1980s.
After fiscal expansion averted the worst in 2009, unconventional monetary policies, primarily “quantitative easing” (QE), became mainstream. The European Central Bank (ECB) followed the US Federal Reserve’s (Fed) QE policy for over a decade.
The low interest rates caused by QE made more credit available and led to increased borrowing. With developed countries offering less concessional loans, developing countries had no choice but to turn to the market for credit.
Government borrowing is necessary for counter-cyclical spending during downturns, but quantitative easing made borrowing easier and cheaper. The resulting borrowing surge is coming back to haunt these economies in 2022-23 and beyond, when interest rates soared.
Debt imposition
The World Bank used slogans such as “From Billions to Trillions” to urge developing governments to borrow more on market terms to meet financing needs for the Sustainable Development Goals, climate and the pandemic.
With capital accounts opening up, many private investors have long sought “safety” abroad. But when lucrative direct investment opportunities arise in places like India, some of the “capital flight” has returned, usually as foreign investment with privileges and protections provided by host governments and international treaties.
QE made credit easily available on mostly concessional terms, allowing for greater and often more innovative financialization: blended finance and other such innovations promised to “de-risk” private investment, especially from abroad.
Despite less bank borrowing than in the 1970s, debt rose due to increased market-based debt, but this debt did not grow the real economy much, even as private innovation flourished.
Borrow Sour
The Federal Reserve blamed the inflation on a tight labor market and began raising interest rates at the start of 2022. As interest rates soared, debt became more onerous.
As a result, government borrowing around the world became more limited at a time when it was more necessary. Rising interest rates suppressed demand, including private and government spending on investment and consumption.
However, the recent economic contraction has been primarily due to supply-side disruptions: Cold War II, the COVID-19 pandemic and geopolitical economic aggression have disrupted supply lines and logistics.
Raising interest rates suppresses demand but does nothing to address supply-side disruptions. Inept policies have not helped, and these inflation-fighting measures have reduced jobs, incomes, spending and demand around the world.
For some it’s even worse
Successive US presidents have been successful in maintaining full employment since the global financial crisis of 2008. While all central banks are committed to ensuring financial stability, the US Federal Reserve also has an almost unique second mission: maintaining full employment.
Developing countries currently face many constraints on their actions: Most are highly indebted and have little policy room to maneuver. With increased market financing, pro-cyclical biases become more pronounced.
Fragile developing countries see little choice but to succumb to the market: poverty in the poorest countries has not fallen in nearly a decade, and food security has not improved for even longer.
To make matters worse, geopolitical pressures are forcing countries in the global south to increase their military spending, yet the recent rise in food prices has been the result of speculation and “artificial” shortages rather than real shortages.
Poor Worst
Heavy debt burdens increase the likelihood of distress. Debt stress has increased significantly over the past two years, especially in developing countries that have borrowed heavily in major Western currencies.
The obvious reasons for central banks to raise interest rates are hardly mentioned anymore, but interest rates are not falling and money is not flowing back to developing countries.
For at least a decade, the United States has increasingly warned developing countries against borrowing from China, despite China’s low interest rates compared with most other sources of credit except Japan.
As a result, Chinese lending to developing countries, especially in sub-Saharan Africa, has declined since 2016. By 2022, poor countries were borrowing significantly more from commercial sources. But then that private capital fled to the U.S. and other Western markets, which offer higher returns and safer loans.
Capital outflows from developing countries, especially the poorest countries, continued as market flows to the poorest countries were significantly reduced, leaving them in the most vulnerable positions with fewer financing options.
Negotiating with a range of private creditors in the marketplace, rather than through government-to-government arrangements, has proven much more difficult. When a significant amount of financing comes from private markets, such lenders are less likely to take direction from the government unless they are forced to do so.
There is therefore little realistic hope for significant debt relief, let alone a stronger recovery in the South or improved prospects for sustainable development.
