Will Coronavirus Cause A Debt Crisis

The coronavirus crisis is causing major economic issues all over the globe.

Governments all over the world are certain that this public health crisis could soon be overshadowed by the financial crisis that it will end up causing in the long run.

The developed world is already under a deluge of debt. This means that the entire world economy is like a house of cards right now. It is precariously placed, and even the smallest of events can trigger a debt crisis of unseen magnitude.

In this article, we will explain the reason behind the debt crisis as well as the impact which it is likely to have.

Asset Price Deflation

Firstly, it is important to understand that worldwide debt is already inflated. In order to get out of the 2008 crisis, countries followed loose monetary policies.

The interest rates were kept at near-zero levels for many years. As a result, a tremendous amount of money supply was created in the system. All this money went into different asset classes. This is the reason that all assets be it stock, housing, debt, precious metals have all been exorbitantly priced until now.

The continued creation of easy money has been fuelling this bubble for many years. However, with the Coronavirus crisis on the horizon, it is not possible to sustain this cycle by continuing loose monetary policies. This is the reason a lot of assets are going to lose value. This means that a lot of banks will also find themselves holding collateral assets that do not have enough value to cover the loans that they have made.

Also, since banks will see the values of their collaterals collapsing, they might end up calling in the loans, which could lead to a further loss in the value of the underlying assets.

Sovereign Debt Crisis

The debt crisis will not be limited to the financial markets. It is likely to morph into a full-blown sovereign debt crisis. This is because most countries in the world do not pay back the money that they borrow from investors. Rather, they keep on paying interest in perpetuity. Then, when the debt finally matures, the government simply borrows from a new set of investors to pay back the old ones.

However, with the coronavirus crisis, investors are not willing to invest more money in the market. On the contrary, they are looking to take their money out of the markets. To make matters worse, a lot of sovereign debt bonds are due to mature in the next six months or so.

Governments will find themselves unable to roll over the debt. The problem will be compounded by the fact that the government will not even be able to dip into its reserves. Any money that the government has may already be earmarked for more humanitarian causes, such as preventing a large number of people from dying of starvation.

The truth is that most of the governments today are overleveraged. For instance, some time ago, experts were wondering about how the world will survive smaller events such as the Brexit. Now, we are in the middle of a full-fledged international crisis. The ability of the governments to deal with something like this is questionable, at best!

Corporate Debt Crisis

Governments are not the only entities that have borrowed beyond their means. Most of the big corporations in the world are in debt. To make matters worse, a lot of this debt is owned by foreign investors. Also, just like governments, corporations do not pay off their debt in full. They too borrow from one investor to pay the other. Hence, just like governments, they too will not be able to roll over their debt.

However, they will not have the option to default like governments. Creditors will initiate default proceedings against corporations. This means that the corporations will have to cut down expenses and sell assets in order to pay off the creditors. Companies will stop borrowing more money even for viable projects because they will be unsure of the larger economic environment. The coronavirus crisis is likely to cause the corporate debt bubble to pop, and the results are likely to be painful.

Personal Debt Crisis

All of the above-mentioned points will indirectly have an effect on individuals.

For instance, the asset market collapse will deflate the savings of the individual. Similarly, the sovereign debt crisis will impact the ability of the government to give out hand-outs.

Lastly, the corporate debt crisis will result in people losing their jobs. This could be devastating, given the fact that households are also highly leveraged.

Hence, if people lose their jobs, they will not be able to make their mortgage payments, rent, student loan payments, and even utility bills. This will create a cycle of despair wherein reduced demand from the household sector will lead to more job cuts. The cycle will be unlikely to stop until the negative sentiment is present in the market.

The bottom line is that every sector in the economy has already borrowed beyond its means. In the midst of all this, the coronavirus crisis is causing forced and immediate deleveraging. This is likely to cause immense economic pain across a wide spectrum of industries.

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