With global debt levels at record highs, both on nominal and relative measures, one wonders which is the next shoe to drop. This week’s focus has been on emerging markets, especially Turkey and basket case Venezuela; anyone might be next. Creditors work with a system like that of a ship’s radar, constantly sweeping for other vessels and obstacles in the way, measuring distance and likelihood of collision; incessant searching.
What are they looking for? Anything unusual, unexpected, signs of stress or weakness, and of course a skipped payment. Changes in popular opinion and politicians, changes in the law or terms and conditions, a deteriorating economic outlook, rising unemployment – all are potential signs of trouble.
Then it depends on whether debt is denominated in local currency or that of another (usually stronger) nation. Sovereigns and economic policies pursued by their leaders have a greater, and not necessarily good, impact on local debt. They can print their own money, encourage banks to lend a lot, boost pay packets of state workers and ensure generous pensions; this, of course, is likely to create inflation. Inflation shrinks all debts, state, corporate and personal, so suits borrowers. For centuries, European countries used to shrink the weight of silver in their coins, mixing in other (cheaper) base metals, hence the term ‘debasement’; the latest in a long line, five noughts chopped off the Venezuelan bolivar this Monday.
The Bank of England tweeted a note about deflation this week, warning why falling consumer prices were a problem. http://edu.bankofengland.co.uk/knowledgebank/what-is-deflation/?sf91727247=1
Central banks allege they are looking for a ‘Goldilocks’ scenario, an expression economists have latched on to meaning economic growth that’s not too hot, nor too cold, but just right. They believe 2 per cent inflation will produce this, hence so many have joined the bandwagon. They also realise that deflation causes indebtedness to increase over time.
External debt is a trickier proposition, and often involves loans from the International Monetary Fund (IMF), unwelcome political interference, austerity and loss of face; Greece has been through this mangle and, while some say it escaped the process on Monday, the reality is they’re still saddled with huge debts – denominated in euros. Bankruptcy is always an option, but an expensive one, as pariah status usually means no access to external credit for years to come – something Argentina has experienced on several occasions since independence from Spain, ironically a movement spearheaded throughout South America by Venezuelan Simón Bolivar.
Personal debts today are no longer enforceable by imprisonment, as was the case for Charles Dickens’ dad. However, some loan sharks, drug dealers and traffickers have seriously unscrupulous methods to keep their businesses afloat. Loans secured by an asset, such as securities, mortgages and cars, are settled by confiscation, not a banker’s preferred method because it’s ugly and time-consuming.
A well-worn method of settling unsecured loans is to ‘lend, extend and pretend’, politely called renegotiation. Non-performing loans (NPLs) at EU banks have to be classified, the European Parliament insists, into 90 days past due or unlikely to be repaid in full; they realise these are the cause of “the low aggregate [bank] profitability”. Traditionally warnings flag up as soon as a bank’s NPL portfolio is more than 5 per cent of the total loan book. Another rule of thumb is when a bond trades at less than 80c in the euro – chances are it could become worthless.
