What would the World do without the Fed?

We shared with you our commentaries on financial markets and economy every Saturday night during the pandemic. Last Thursday, we met again with Levent on an Instagram livestream. Mr. Levent had some warnings to deliver to our audience.

“Fed won’t stop trying to help financial markets gather their strength back”, he said. And just like Levent guessed, in his recent presentation of the semi-annual monetary policy report to the Senate Banking Committee, Fed Chair Powell retold each and every action taken by the Fed during the virus outbreak, repeating that the Fed will use every financial instrument available to boost the U.S. economy in these hard times.

This speech of Powell was rather interpreted like this, “Not only bills, I might buy corporate bonds as well if need be”. I think I would not sound too unrealistic if I say that, if it weren’t for the Fed, the U.S. Government may not be able to manage its huge pile of debt. For that matter, no country in the world could manage its debt if it weren’t for the Fed. Developed Countries seem to experience more difficulties in this matter when compared to developing countries because the largest pile of debt is incurred by the world’s largest economies.

“An amount of debt that can’t be paid off…”

While debt-to-GDP ratio in emerging economies was around 20% in early 20th century, developed countries, on the other hand, incurred enormous levels of debt like 40%. Despite countless bankruptcies and moratoria across Latin America, people continued to lend and borrow money. Debt held by the governments was at its highest level during the World War II, where debt-to-GDP ratio in Developed Countries exceeded 120%, while in developing countries, it rose above 40%. During its first 15 years, Republic of Turkey adopted a rather cautious approach to borrowing, avoiding going into any debt if no project was offered in return.

Despite the post-World War II poverty, national governments’ debt levels once again fell to 40% thanks to strong efforts to achieve economic growth and industrial development. After the 1970s, however, developing countries and developed countries somehow became very competitive in terms of borrowing funds, which, I think, was closely associated with the invention of “positive real interest rate”. With the emergence of Financial Liberalization towards the end of the 1970s, the fact that conservative governments grew public sector through excessive borrowing led to a huge level of debt of 80% in the year 2000. Although Turkey’s debt levels sometimes seemed quite high, average level of debt remained around 40-50% due to the fact that investors preferred developed countries over developing countries when it came to lending money.

The 21st Century, however, presents an entirely different financial scenery where the debt ratio in developed countries are fluctuating between 40% and 60%; in developing countries, have already increased their debt level up to 120% again (their former level during the WWII) using 1997 Asian financial crisis and Financial crisis of 2007–2008 as an excuse. In the meantime, the average amount borrowed by developing countries hit a record high level of 65%. In short, today, every country in the world has external debt while the developed ones have the highest levels of debt. I don’t think an economic performance exists to pay off such huge debt pile. Also, we should know that advanced economies will be the cause of the next financial crisis.

So, as I said before, no country in the world could manage this major pile of debt without the Fed. Ensuring the survival of capital markets by buying government securities and individual corporate bonds, Powell and his team may face some hard times if a second wave of coronavirus strikes. As China spike continues with new cases, I think everyone sees more clearly now why OECD has taken the step of presenting a second-wave scenario in its latest report.