When will cheap credit dry up?

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Low borrowing rates have made us complacent. The forces holding interest rates down, however, are eroding. Highly indebted governments, businesses, and individuals are dangerously exposed to interest rate risk.

In developed countries, many politicians and their pundit enablers say that cheap credit means we don’t need to worry about the debt. Denying reality may be politically convenient, but fact tends to catch up.

Instead of irresponsible short-termism, times of plenty should be used to prepare for lean times to come. Unfortunately, many play Aesop’s carefree grasshopper instead of the prudent ants.

Interest rates can’t stay low forever. They are the price of lending, and prices reflect the relationship between supply and demand. Global interest rates relate the stock of global savings to borrowing, such as investment opportunities.

Global savings, mainly from a growing global middle class, have increased enormously, and funds cross borders more easily. On the demand side, investment opportunities have not been plentiful enough to absorb the savings without interest rates dropping. 

The global financial crisis and the Great Recession helped keep rates low, as have more recent international disputes. Interest rates have been driven down to unprecedented lows for a generation, and many assume they are here to stay.

Now, however, rapid improvements in the business climate — reducing the cost of starting and operating businesses — should stimulate expansion in demand for funds. Rapid progress in some of the world’s most populous countries could supercharge this process.

In this way, the World Bank’s Doing Business 2020 report is a warning on interest rates, though it has good news for global prosperity. The report measures how easy it is to start and operate a small- to medium-sized business in each country.

It looks at costs and time for getting permits, electricity, and authorization to import or export, as well as the quality of construction, the legal system, and bankruptcy practices, among other metrics.

The prior edition, Doing Business 2019, vast measured improvements in China: 8.64 points, moving up to rank #46 out of 190 jurisdictions with 73.64 points on a 100-point scale. India improved by 6.63 points to rank #77 with 67.23 points.

These were stunning rates of progress. India continues to lag China, but its score last year exceeded China’s from the year before. 

In Doing Business 2020, China improved again to a score of 77.9 and a rank of #31, further closing the gap with the United States (#6, 84.0 points). India climbed to #63 with 71.0 points. 

India and China each gained about 15 points in the last five years. Nearly 40 percent of the world’s population lives in those two countries. 

Other populous countries have also improved a lot, including Bangladesh, Nigeria, and Pakistan, together with another 7.5 percent of the world’s population. 

Even as business climate reforms expand investment opportunities, the growth of savings may start to slow. China’s population is aging rapidly.

As many pass peak earning years, the pool of excess savings from China will likely grow more slowly, perhaps even stagnate. Slowing savings growth could also push up interest rates.

A wealthier world is a cause for celebration, but it’s not all upside for heavy borrowers. Higher interest rates require higher interest payments.

For the federal government, each one percentage point increase in interest rates implies an additional $1.8 trillion increase in debt service over the next decade. Sooner or later, the ballooning debt will require cuts to government services, tax increases, or both.

The expansion of diversification opportunities as business investment expands could also reduce demand for U.S. Treasury debt. Major rating agencies, as well as CBO and GAO, see the federal debt path as unsustainable, and cracks may be starting to show.

The bid-to-cover ratio for national debt may already be declining, and the Fed’s decision to purchase more Treasuries could be interpreted as propping up demand.

These warning signs shouldn’t be ignored, especially facing geopolitical competition from China.

Fortunately, Americans may still have time to get our collective act together if we act soon. At all levels of government and society, reducing exposure to interest rate risk means reducing our debt burdens.

It will require setting priorities and making choices, yet waiting until a crisis has arrived is far too late to change course responsibly. The sooner we accept reality and deal with our problems, the less severe the lean times to come will be.

Kurt Couchman is a co-director of legislative strategy at the Committee for a Responsible Federal Budget. He previously served in the offices of several members of the U.S. House of Representatives.


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