Enormous government budget deficits and technology companies’ insatiable demand for cash are threatening to create a credit crunch that could precipitate a wave of global economic turmoil.
This warning from leading economists follows concerns from big businesses, central banks and treasury departments around the world – including in Australia – about a surge in interest rates on the debt held by governments and increasing bouts of geopolitical uncertainty due to the actions and rhetoric of the Trump administration.
Leaders from across the business, banking and government sectors have told this masthead they are troubled by what some called a “perfect storm” of economic conditions, but requested anonymity to discuss the issue.
While central banks set a nation’s official cash rate and govern the cost of money in a particular country, interest on government and corporate bonds are set by investors. If the rates are higher, the government needs to devote more of its income to repaying debt and less to services.
Interest rates on government bonds have soared in recent weeks as investors have demanded higher returns for holding public debt. Japanese interest rates hit a 30-year-high last week, up 40 per cent since March. A 20-year-high was reached in the US and rates on 10-year Australian government debt reached their highest since 2011.
Governments are competing with tech companies for investor attention amid predictions the boom in AI infrastructure could cost $US1 trillion this year.
Investors have also been spooked by signs that global inflationary pressures are climbing, which will force central banks to keep their interest rates higher for longer. This will prompt investors to further lift rates on government bonds. The war against Iran continues without a resolution and Brent crude on Saturday reached a five-month high of $US92 a barrel.
Former Commonwealth Bank chief economist Michael Blythe, co-founder of PinPoint Macro Analytics, said investors were finally waking up to the huge level of debt held by governments around the world.
He said Australian debt hitting $1 trillion last month had been a wake-up call. It was worse overseas, where the US debt reached $US40 trillion ($55 trillion) and its budget deficits were about 6 per cent of GDP.
“That’s a lot of debt that has to be absorbed. We’re getting closer to the red line than we were,” he told this masthead.
“If there isn’t a slowdown in investment or in debt, then you end up in financial turmoil, in a credit crunch, and that leads you into [global] recession.”
Government interest rates had fallen ahead of the US-led war against Iran but they have since jumped. British and German government interest rates have lifted by more than 20 per cent over the past six months while Australian rates have climbed by 12 per cent.
Confusion over US economic policy remains elevated. After stronger than expected job figures increased expectations that the Federal Reserve would lift interest rates at its meeting later this month, US President Donald Trump at the weekend threatened to stop international trade with some countries if rates were not cut.
“We should have the LOWEST RATE of any country in the World … LOWER THE RATE OR I’LL STOP TRADING WITH COUNTRIES WITH WHICH WE HAVE A DEFICIT,” he posted to Truth Social.
Strong jobs growth, especially during a period of high inflation and low unemployment, usually leads to higher interest rates. America ending trade with countries such as China would plunge the world into a recession.
AMP chief economist Shane Oliver said the situation was being made worse by the US, labelling Trump’s call for America’s central bank to cut interest rates as “illogical”.
He said the lift in bond interest rates was bad news for all governments in Australia, particularly states as they were likely to experience a drop in their stamp duty revenues.
“The more bond yields rise, the faster the public debt interest bill will rise and the more tax revenue it will take up, leaving less left over for welfare payments and other government spending,” he said.
“It [also] means higher corporate borrowing costs, which can act as a dampener on company profit growth. And it means that banks are likely to raise their fixed mortgage rates, which will reduce the attractiveness of fixed-rate mortgages as an alternative to variable-rate mortgages.”
Predictions of major global turmoil are not unanimous. Prominent American-based Australian economist Justin Wolfers played down those concerns, saying the increase in global interest rates had been “orderly”.
“There’s nothing that looks disorderly about this. There’s nothing that puts us on the edge of a crisis,” he said.
“But this still affects your life, because even if it’s an orderly movement, what you’re going to see is higher interest rates and it’s going to be higher interest rates on everything.”
Low interest rates on government debt leading up to and through the pandemic hid some of the problems now being faced around the world.
In his final budget as treasurer in early 2022, Josh Frydenberg forecast government debt interest would average 2.2 per cent. That meant the interest bill on a forecast gross debt of $1.17 trillion in the 2025-26 financial year would reach $26 billion.
In this year’s budget, Treasurer Jim Chalmers forecast an average interest rate of 4.8 per cent. That higher rate has meant that in 2025-26, despite gross debt being around $970 billion, the interest bill on it was closer to $27.6 billion.
If the current run-up in interest rates continues, Chalmers will have to forecast an even larger interest bill in his mid-year budget update.
It’s not an issue just for taxpayers. Major business leaders are increasingly worried that the combination of high rates on government debt, the competition with tech companies for private investment dollars and the turmoil out of the US are fuelling economic instability.
Stephen Koukoulas, a former economic adviser to Julia Gillard who is now a private sector economist, said the US government bond market was the most important and supposedly secure in the world.
So balanced was the economy at present that a small unexpected event, such as a low number of bidders on a US bond auction, could be enough to trigger a global crisis, he said.
“You end up in a situation not all that different to the global financial crisis. The capital markets stop working. Businesses stop investing because it doesn’t make sense for them to do so. You end up with fewer jobs. You end up with a recession,” he said.
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Shane Wrightis a senior economics correspondent for The Sydney Morning Herald and The Age.Connect viaXoremail.
