When Will Global Debts Reach The Tipping Point?

Even as the global economy begins to recover, a new IMF report warns that growing sovereign debt could create a new global financial crisis. One of the largest threats to the potential new crisis is the level of underperforming private assets that have been transferred to the public sector, creating long-term debt obligations for many countries. See the following post from The Capital Spectator.

We’ve heard it before, but the IMF is telling us again: there’s a lot of debt sloshing around in the global economy, and more is on the way. The question before the house: At what point will ballooning deficits reach the financial tipping point? Whatever the answer, we seem to be moving closer to that hazardous peak. That doesn't mean we're destined to reach it, but the alarm bells are now ringing loud and clear.

“The global financial system and the world economy are slowly regaining their health, thanks in large part to unprecedented interventions by governments,” the IMF advises in its newly published Global Financial Stability Report. “But the sharp rise in government debt during the economic crisis from already elevated levels helped create… the newest threat to the financial system: growing sovereign risk.”

A chart from the report summarizes the trend. The ratio of sovereign debt to GDP in the G7 countries is approaching 120%, which is near a 60-year high. "Some sovereigns have also been vulnerable to refinancing pressures that could telescope medium-term solvency concerns into short-term funding challenges," the IMF advises.



Sovereign risk has been a topical subject of late, including on these digital pages, such as a look earlier this month at new red ink commentary from the Bank for International Settlements. In broad terms, the IMF essay doesn't really bring anything new to the table, although it certainly adds a powerful voice to the mounting list of alarms issued from economists and other observers of the macro scene.

The core issue, the IMF asserts, is that "the biggest threats have moved from the private to the public sectors in advanced economies. Governments not only took on many of the bad assets from private institutions but due to the recession face continuing heavy borrowing needs for the next few years."

In another graphic from its report, the IMF contrasts recent trends for several macroeconomic risks. As the chart below shows, the IMF counsels that sovereign credit risk has worsened since last October—in sharp contrast to the otherwise improving state of the macroeconomic environment.



The good news is that the "the world economy is recovering from the global crisis better than expected," the IMF advised in another report, which was published today. That's no small trend in generating the cash flow needed to pay down the world's rising debt load. "In its latest World Economic Outlook (WEO), the IMF said among the advanced economies, the United States is off to a better start than Europe and Japan," according to a statement. "Among emerging and developing economies, emerging Asia is leading the recovery, while many emerging European and some Commonwealth of Independent States economies are lagging behind." The new WEO projects that world economic growth this year will 4.2%, up from the predicted 3.9% in January. And the U.S. will grow by 3.1% in 2010, up from the 2.7% forecast from earlier this year, according to the IMF. But even amid this encouraging outlook, the statement added that "sovereign risks in advanced economies could undermine financial stability gains and extend the crisis." The forces of light and dark are headed for battle.

"When investing abroad, it's always important to look at the country's sovereign rating," writes Randy Epping in The 21st Century Economy--A Beginner's Guide. "Usually, a sovereign government is almost always a better credit risk than a company in that country. This is because the government, in theory, will always be the last to go bankrupt." But perhaps This Time is Different.

This article has been republished from James Picerno's blog, The Capital Spectator.