The compacts we need

Fiscal policies will have to be fundamentally repurposed to bring advanced countries’ debts down to safe levels, avoid global instability and renew social solidarity.

- Tharman Shanmugaratnam

When I started off as an economist at the Monetary Authority of Singapore in the early 1980s, the Latin American debt crisis was threatening global financial stability. Debts in several of the continent’s economies surged to 70 per cent of GDP on average — well beyond the threshold considered sustainable at the time. It took a whole decade to resolve the crisis.

Today, it is the advanced economies that feature many of the same traits, but on a much larger scale. The G-7 countries have government debts averaging 120 per cent of GDP. Governments depend on central banks to keep interest rates down to avoid a self-reinforcing escalation of debts. And with polarised and fragmented politics, governing parties find it difficult to tighten the fiscal belt without losing the next election.

A GROWING SYSTEMIC RISK

What’s different is that they are accumulating debts without the constraints that emerging markets face. They can borrow in their own currencies, they have deeper bond markets, their central banks have relative independence, and the markets simply give them favour as advanced countries.

But it is this very leeway that allows them to run up systemic risks. No one knows exactly where the limits lie, but ever-growing debt ratios will increase the interest rates that lenders demand, lead to chronic financial instability, erode trust in reserve currencies, and ultimately weaken growth globally.

Sentiment can also change suddenly, as we saw in the UK bond market revolt in September 2022 - the so-called “Liz Truss” moment. And markets today are more fragile for the fact that key participants, like hedge funds, are themselves highly leveraged.

Yet the largest fiscal challenges still lie ahead. Government budgets will be strained by ageing societies, the unavoidable need to address climate change, and the bolstering of defences in several countries amidst geopolitical disorder.