The risks of the global Covid debt bridge

Share on linkedin
Chalk logo


Markets seem unconcerned that the pandemic has left borrowing at all-time highs

Early in the Covid-19 pandemic, it became clear that the global economy would require a massive extension of public and private debt to avoid an extraordinarily deep and persistent depression.

Because this unprecedented explosion in debt provided a “bridge” over the collapse in world output, corporate bankruptcies and economic hardship for households have been significantly mitigated.

In light of the progress on vaccines, investors can be more confident that the end of the debt bridge is in sight. Nevertheless, this year’s surge in borrowing has been called the largest wave in a great “debt tsunami”.

The Institute of International Finance recently reported that the ratio of global debt to gross domestic product will rise from 320 per cent in 2019 to a record 365 per cent in 2020. The IIF concludes starkly: “more debt, more trouble”. Financial markets have ignored these warnings. Global equities have reached new highs and credit spreads have been narrowing, almost as if extreme debt is a good, not a bad, economic development.

It is a stretch to share this optimism over the long term. As the World Bank explained in December 2019, previous waves of debt have frequently ended in global financial meltdowns, including in Latin America in the 1980s, Asia in the mid-1990s and US housing in the 2000s. The World Bank says another wave of emerging market and global debt started in 2010, but this has shifted to an entirely new level this year.

Is this a serious near-term threat to the stability of financial markets? Here, the verdict seems more encouraging.

Macroeconomic conditions offer some support for higher debt ratios. The forces of secular stagnation have created a further excess of global savings over investment, reducing equilibrium real interest rates and inflation. This has encouraged central banks in advanced economies to purchase about 63 per cent of the rise in their government debt, mitigating the risks of funding crises.

The safety net offered by central bank support, notably by the US Federal Reserve, has been greatly extended compared with previous crises. Market-maker of last resort functions have prevented liquidity problems that would otherwise have tightened global financial conditions. These actions have made debt crises far less likely.

The immediate provision of large-scale dollar swaps to emerging economies has reduced the severity of dollar shortages. Many emerging market central banks have started their own quantitative easing, despite weakening currencies that might trigger inflation.

The Fed has also provided direct lending to corporates, state and local governments, and households, supported by capital injections from the US Treasury. Although these facilities have not been greatly used, they have been a game changer by providing a backstop for credit markets, unlocking trillions of dollars of private sector lending.

Economist Paul Krugman has correctly compared the effect of these initiatives with the “whatever it takes” speech of Mario Draghi in 2012 when he was president of the European Central Bank, which effectively ended the euro crisis by promising unlimited central bank intervention if needed.

While Treasury secretary Steven Mnuchin has now started to withdraw this support in defiance of unambiguous advice from the Fed, it seems probable that expected new secretary Janet Yellen will keep the facilities operating by using the Exchange Stabilisation Fund in any new emergency.

A final contrast with the 2008 financial crisis is that households now account for a much smaller fraction of the extra global debt, and the banking sector seems better capitalised and less leveraged. But global debt should not be treated as a homogenous commodity. Its distribution is perhaps more important than its total and, clearly, some categories should cause concern. These include US corporate debt, already a headache, and now greatly increased in the consumer sectors most damaged by Covid-19. Small and medium-sized companies are facing severe bank funding stress, especially in the EU.

China has also been a dominant contributor to the 2020 debt surge, and the authorities are trying to dampen a property boom by restricting credit growth, thus slowing the expansion in GDP. Other emerging market debt is clearly a potential problem, especially in the low-income group.

A far more dangerous, systemic debt crisis probably requires a reversal of secular stagnation, and a rise in world inflation, forcing the Fed to tighten monetary policy significantly. Luckily, that still seems a very long way off.

Source: This note is based on material which appeared in an article by Gavyn Davies published in the Financial Times on 30 November 2020.
This material is for your information only and is not intended to be used by anyone other than you. It is directed at professional clients and eligible counterparties only and is not intended for retail clients. The information contained herein should not be regarded as an offer to sell or as a solicitation of an offer to buy any financial products, including an interest in a fund, or an official confirmation of any transaction. Any such offer or solicitation will be made to qualified investors only by means of an offering memorandum and related subscription agreement. The material is intended only to facilitate your discussions with Fulcrum Asset Management as to the opportunities available to our clients. The given material is subject to change and, although based upon information which we consider reliable, it is not guaranteed as to accuracy or completeness and it should not be relied upon as such. The material is not intended to be used as a general guide to investing, or as a source of any specific investment recommendations, and makes no implied or express recommendations concerning the manner in which any client’s account should or would be handled, as appropriate investment strategies depend upon client’s investment objectives. Funds managed by Fulcrum Asset Management LLP are in general managed using quantitative models though, where this is the case, Fulcrum Asset Management LLP can and do make discretionary decisions on a frequent basis and reserves the right to do so at any point. Past performance is not a guide to future performance. Future returns are not guaranteed and a loss of principal may occur. Fulcrum Asset Management LLP is authorised and regulated by the Financial Conduct Authority of the United Kingdom (No: 230683) and incorporated as a Limited Liability Partnership in England and Wales (No: OC306401) with its registered office at Marble Arch House, 66 Seymour Street, London, W1H 5BT. Fulcrum Asset Management LP is a wholly owned subsidiary of Fulcrum Asset Management LLP incorporated in the State of Delaware, operating from 350 Park Avenue, 13th Floor New York, NY 10022.

About the Author

Gavyn Davies

Gavyn Davies is chairman of Fulcrum Asset Management and co-founder of Active Partners and Anthos Capital. He was the head of the global economics department at Goldman Sachs from 1987-2001 and chairman of the BBC from 2001-2004. He has also served as an economic policy adviser in No 10 Downing Street, and an external adviser to the British Treasury. He is a visiting fellow at Balliol College, Oxford.

Gavyn Davies
Your privacy

Cookies are data files that are stored on your computer or other smart device by a website’s server. Each cookie is unique to your web browser. It will contain some anonymous information such as a unique identifier, website’s domain name, and some digits and numbers. Cookies are useful as they allow us to recognise a user’s device and its preferences in order to ensure that our website works properly. By continuing to use this website, you consent to the use of our cookies.


You can find out the different types of cookies used on our website in our Cookies and Data Privacy Policies.

Necessary cookies