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Tuesday, April 07, 2020
Grey Rhino of Debts and the Change of Global Financial System
ANBOUND

Since the financial crisis in 2008, all major economies have adopted quantitative easing (QE) to cope with the problem via injection of liquidity into the economy. After 10 years of managing the crisis, the loose monetary policy in most countries' central banks is beginning to see success in absorbing the financial crisis' damage towards the global economy, though at the risk turning the problem into a "grey rhino" that will affect economic development and financial market stability. Data from the Institute of International Finance (IIF) shows that the global debt-to-GDP ratio reached 322% third quarter last year, a record high. At the beginning of this year, the Covid-19 pandemic has brought unforeseen implications to the global financial market and real economy. Many countries worldwide have issued large-scale stimulus policies to counter the pandemic, which has caused the global debt to continue expanding. Due to the two crises in the past decade, ANBOUND researchers believe the impact-absorbing debt measures promoted by governments in most countries have caused the overall capital surplus to take a turn for the worse, and will continue to change the global economy and the financial system.

Currently, to alleviate the pandemic's impact on the economy and financial markets, central banks like the Federal Reserve are promoting unprecedented easing policies. More than 50 central banks have launched monetary easing policies, which causes the global debt scale to further increase. Rating agency Standard & Poor predicts the size of global government debt will jump to a record of US$ 53 trillion by the end of 2020, of which US$ 8.1 trillion was borrowed this year. Concurrently, many institutions have reached the consensus that this year's global economic will experience a negative growth due to the pandemic. The latest report from the United Nations Department of Economic and Social Affairs (DESA) expects the global economy to shrink by 0.9% in 2020 under the presence of the pandemic. Many research institutes are now cautioning countries of the implications these impacts will have on the global economy's recovery following the outbreak. Like ANBOUND said, both the global economy and financial system will descend into a more vulnerable state than before under monetary easing, thereby making the "Grey Rhino" global debt a larger and an even more obvious threat

The snowballing global debt has caused asset returns to experience continuous declines, which may be a significant problem for financial markets and governments in the future. IIF's latest Global Debt Monitor report shows the rate of return in newly issued debt is gradually decreasing. Under major global central banks' easing policies, global bond yields have continued to decline. Currently, the yield of 10-year U.S. Treasury bonds has fallen sharply, and 25% of investment grade bonds have fallen into the negative yield range. It is precisely due to the overall growing debt scale worldwide that the global debt's growth rate has exceeded that of GDP. This results in a sharp drop in market interest rates, or the ratio in countries with high debt rates will rise rapidly. The continuous expansion of low-interest rate globally and monetary environment with negative interest rate has altered the valuation of equity assets. Consequently, long-term low interest rate and investment environment with negative interest rates have prompted investors to pair assets with high risk and poor liquidity to pursue returns. The U.S. stocks may have gone through the historical bull market in the past decade or so, but the vulnerability in the financial markets will be aggravated, nonetheless.

Additionally, ANBOUND has previously pointed out that the act of central banks worldwide to save the market through extremely loose monetary policies has filled the hole of the previous bubble with an even larger credit bubble. This prevents the market from being fully restored, and causes risks to continue accumulating. On the other hand, however, the increased liquidity in the central banks' stimulus has intensified the degree of capital surplus. Based on the "Crisis Triangle" theory as explained by ANBOUND Chief Researcher Chan Kung – Excess capitals will intensify under low interest rates and in doing so, increases the degree of economic virtualization when it enters the financial market, making capital surplus a norm in the world economy and an integral part in the normalization of the global market. This "new normal" in the global financial system means that global debt will continue to accumulate and deepen, subsequently reducing the level of investment and trade activity.

The continuous increase in global debt means the global economic and financial systems have increased tolerance for credit and debt expansion after the financial crisis. At the same time, governments in many countries are finding it harder to withstand the volatile capital markets. Judging by the changes in the capital market and the Fed 's policies in the recent years, the monetary policy is getting more and more affected by the capital market, which makes it hard to be normalized. As for credit risk, while various international rating agencies are constantly adjusting their credit ratings given the current situation, the entire credit evaluation system may undergo fundamental changes. The governments in various countries are getting more and more involved in their influence and intervention towards the market, and in turn, market risks and corporate credit risks are increasingly affected by sovereign credit and government supervision, which will bring about the re-pricing of global capital markets. This time around, with the crisis on hand, the role of central banks worldwide has gone from being the "final borrower" to becoming the "final purchaser" for financial assets. From investors' perspective, the risk assessment will be reduced, resulting in an "asset shortage" of low-credit risk assets that would cause the stock market to be even more volatile. Therefore, the World Bank cautions governments and central banks to realize that historically, low interest rate levels are not enough to offset another potential global financial crisis, and countries need to be aware of the potential global debt risks.

What's more worrying is the current global debt scale and the expanding range of negative interest rates cannot be explained by means of traditional economics. Therefore, issues like how to effectively prevent the debt scale from further increasing in various countries and return the interest rates to a normal range are commonly faced problems by the economics community in recent years. Neither Keynesianism nor monetarism has encountered the current tricky situation of high leverage, low inflation, and low growth. In recent years, the rapid development of the financial industry driven by science and technology has caused the relationship between money and economic growth to change. Finance is having a larger impact on the economy, and it is forming a relatively independent circulation system too. This has not only spawned a bubble of global assets, but also indirectly led to "too big to fall" major financial institutions. The trend of using debt inflation to drive economic growth is super apparent, and a breakthrough in economic and financial theories is required to understand the benign problem that is the cycle of debt problems and economic growth. The exploration of economic growth theory will bring changes to the investment theory, including capital valuation and the reassessment of various risks, which will have a profound impact on the development of the financial system.

Final analysis conclusion:

Under the impact of the Covid-19 pandemic, the government's unprecedented bailout policies in various countries will continue to cause the global debt to grow. This poses an increasingly serious hidden danger for the global economy that is about to fall into recession. Simultaneously, this will also cause changes in the global financial market and financial system. Solving the debt problem, achieving the balance of economic growth, and reducing government intervention in financial markets will be the challenges faced by different countries worldwide in their policies.

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