Past instances in the financial markets have taught us that every crisis situation is usually preceded by a bubble. Remember, the tech bubble in 2001 or the financial or real estate bubble in 2008.
“An economic bubble or asset bubble is a situation in which asset prices appear to be based on implausible or inconsistent views about the future. It could also be described as trade in an asset at a price or price range that strongly exceeds the asset’s intrinsic value.”Wikipedia
So are we currently living in an economic bubble?
In some sense, yes. Over the past decade, economic growth across the world has largely been driven by fiscal expansion by the government of advanced economies. This has led to a gradual increase in government debt to GDP ratio across major economies including India. We have all seen how higher debt can ruin a company’s financial, and here we are talking about countries having debt which are higher than their GDP. And, what’s even worse is that the current COVID – 19 pandemic has led to and would require higher spending from the government in order to save lives and businesses and reduce the economic impact. Below is the table depicting the government’s debt – GDP ratio of some of the major economies of the world.
|Gross Debt as a percent of GDP||2012||2013||2014||2015||2016||2017||2018||2019||2020e|
In 2020, it is expected that the general debt to GDP ratio is likely to witness a sharp increase due to higher borrowings by the government to support the economy. Further, in our view, it is likely to be stop-start lockdown till the time we have a fully working vaccine in place which is at least 12 months away. This means that the government would have to borrow more in 2020 and even in 2021, to support the economy. This will worsen the financial condition of some of the major economies like Japan, US, France, Spain, Italy, which are already running with debts closer to or even higher than their respective GDP.
Will these countries ever pay?
It looks highly unlikely that these countries would ever be able to repay such mammoth amount of debts. It’s only because of their sheer economic size and military power, they believe that would be able to get away with it. Even rating agencies, whose sole job to rate these countries based on their finances, have failed miserably. The US continues to retain its AAA status and Japan an “A” rating.
Further, even countries like Spain and Italy enjoy higher rating whereas India’s is just a notch above junk grade bonds. The only way to get out of this debt is to cut spending or raise taxes. This looks unlikely as each decision would have implications. In the last two decades as well, we have only seen debt levels to increase in order to support growth.
So whats next?
Advanced economies have already succumbed to the vicious debt cycle. They are practically sitting on a ticking bomb that can go bust at any point in time. If gone bust, this would have repercussions on the currency market and interest rates across the globe.
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