U.S. and China debt could cripple global economy, IMF warns

Soaring debt levels in the world’s two largest economies could have “profound” unintended consequences for the rest of the world
By Sam Bourgi
•
06 May 2024
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debt, deficit, crisis

The U.S. and China have very different economies, but they share one thing in common: a credit addiction that’s growing out of control compared to the rest of the world.

According to the International Monetary Fund (IMF), many major economies are taking decisive action to cut their national debt—except the U.S. and China.

“In both economies, public debt is projected under current policies to nearly double by 2053,” the IMF said in its Fiscal Monitor biannual report.

“How these two economies manage their fiscal policies could therefore have profound effects on the global economy and pose significant risks for baseline fiscal projections in other economies.”

The IMF predicts that the U.S. will reach a staggering 133.9% of GDP in 2029, up from 122.1% in 2023, while China’s debt-to-GDP ratio is forecasted to hit 110.1% from 83.6% last year.

A debt-to-GDP ratio above 100% means the government borrows more than its economy produces.

Although there’s no generally agreed-upon threshold for when a country reaches a dangerous tipping point, the IMF thinks the U.S., in particular, is shooting itself in the foot by taking on so much debt.

Among other things, massive deficit spending will make it harder to control inflation, according to the IMF.

“Loose U.S. fiscal policy could make the last mile of disinflation harder to achieve while exacerbating the debt burden,” the IMF said. “Further, global interest rate spillovers could contribute to tighter financial conditions, increasing risks elsewhere.”

The inflation risk

With the recent uptick in inflation, economists have been increasingly warning of "stagflation"—and that's not just a concern for Americans.

In theory, higher inflation means higher interest rates. That typically translates to higher yields on government bonds, which could have negative knock-on effects for other nations.

“Long-term government bond yields in the United States remain elevated and sensitive to inflation developments and monetary policy decisions,” the IMF explained. “This could lead to volatile financing conditions in other economies.”

According to the IMF, a one-percentage-point rise in U.S. bond yields leads to a comparable yield rise in developing countries and a 90-basis-point jump in advanced economies.

“High and uncertain interest rates in the U.S. affect the cost of funding elsewhere in the world,” said Vitor Gaspar, the IMF’s director of fiscal affairs.

According to Fed researchers, rising U.S. interest rates have historically destabilized developing markets, leading to higher debt burdens and capital outflows.

“The international spillovers associated with rapidly rising U.S. interest rates can heighten the likelihood of financial distress in these economies; however, this likelihood depends upon the reasons why U.S. interest rates rise,” wrote Carlos Arteta, a manager at The World Bank.

Artera said higher rates are “particularly injurious when they are driven by market perceptions of more hawkish” Fed policy.

Are the hawks back?

Economists at Bank of America and JPMorgan expect the Fed to adopt a more hawkish tone moving forward. (In the inflation context, a “hawkish” Fed prioritizes controlling consumer prices over lower interest rates.)

Those expectations are partly rooted in recent commentary by Fed Chair Jerome Powell, who said:

“The recent data have clearly not given us greater confidence, and instead indicate that it’s likely to take longer than expected to achieve that confidence.”

“If higher inflation does persist, we can maintain the current level of restriction for as long as needed,” Powell said.

Central bankers’ biggest mistake was “They kind of came out and did a victory lap too soon,” said Ellen Meade, a former Fed employee and current economics professor at Duke University.

According to Barclays’ chief U.S. economist Marc Giannoni, “Inflation data have turned back up this year, and that will force Powell to become a little more hawkish again.”

As a result, Powell is expected to stress that the Fed will “keep policy in its current restrictive stance for as long as it takes” to regain its confidence, said Michael Feroli, JPMorgan’s chief U.S. economist.

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