Global debt explained

Global finance has been a hot topic ever since the Global Financial Crisis in 2008, but trying to work out what it all means can be a challenge. The latest term being thrown around is global debt, and the sharp stock market falls across North American and Europe have pushed the issue to the front page.

What is global debt?
National debt refers to how much money a country owes to other countries or to private banks. Global debt is the aggregation of individual national debts.

How did global debt start?
A number of factors have led to increased global debt, but some events have played a much larger part than others. In the 1970s the members of the Organisation of Petroleum Exporting Countries (OPEC) agreed that they would only sell oil in US dollars. Within three years the price of oil had increased by 400%. Oil-poor countries had to borrow US dollars to buy oil. In the 1980s the interest rate on those loans went up to 20%. This meant that in less than four years debt had doubled. By 2001 many developing countries had paid back the amount they had originally borrowed six times over, but their total debt had quadrupled because of interest owed.

What happened with the GFC?
In the lead up to the GFC the Bank for International Settlements (BIS) increased the capital requirement of its members by 2%. This sent the Japanese banks into a recession from which they have yet to recover. The American banks tried to avoid the same fate by moving loans off their books. To do this they bundled the loans into securities and sold them to investors. Almost anybody could get a loan, and credit levels increased dramatically. When people started to default on their loans, and two hedge funds collapsed, the banks’ activities became public and the US stock market fell dramatically, resulting in the GFC.

How has this affected global debt?
The stock market crash in the USA has led to stock market downturns in most other countries. In response to the GFC the European Union (EU) declared that EU countries could no longer borrow from their own banks or issue money. Instead they must now borrow from the European Central Bank, private international banks or the International Monetary Fund (IMF). The EU has put these rules in place to try and slow inflation, but it has meant that private banks now have much more international economic power.

How is Australia affected?
The publicity that global debt is receiving leaves the Australian public feeling insecure about world finance. People who feel worried about money don’t spend money, and may even pull their money out of the stock market. The Australian economy cannot grow unless people spend, and the stock market will fall if people start to pull out, which creates a cycle of more economic instability and more public worry and so on.

Keeping it in perspective
The billions of dollars that Australia owes can seem like a lot. Just looking at the amount of money owed, however, is not necessarily the best way to understand debt. If instead we consider the ration of debt to GDP we will understand the true debt levels for specific countries. The higher the number, the worse the problem. To give you some idea of where Australia sits here’s a list of some OECD nations and their current ratio of debt to GDP:

•    Japan – 220.3%
•    Italy – 119.0%
•    USA – 91.6%
•    Canada – 84.0%
•    France – 81.8%
•    Australia – 22.3%