Puerto Rico - the canary in our gold mine

Puerto Rico joined Greece in announcing this week that it couldn't pay its debts. As the news sent stock and bond markets tumbling across the planet, a far-off crisis came home to the Caribbean.

Puerto Rico and Greece - and our own island, Jamaica, for that matter - may be extreme cases. However, they are not isolated. Rather, their unbearable debt loads are but small parts of a global picture. Put simply, the world is drowning in unprecedented debt levels.

A report earlier this year by the McKinsey Institute crunched the figures for the world's debt stock and found that, get this, humanity owes itself money. The planet's total debt-to-GDP ratio - including government, corporate and household debt - now stands at close to 300 per cent.

Some of this was taken on in the years following the crash of 2008, and is concentrated in industrial countries. However, the trend of rising debt stretches back decades. After peaking in the early 1980s, interest rates began a long and steady decline over the next 30 years. On one hand, this made investment cheaper, which was potentially good for economic growth. But on the other, it also encouraged both government and private actors to take on more debt.

Moreover, as the Bank for International Settlements (BIS) maintained in a report last week, low interest rates made borrowers careless when it came to investing. An old-fashioned way of putting it is that when something is cheap, you don't treat it as dear. Cheap money wasn't used just to build roads or improve education. It went into spending or fruitless investments, like vanity homes that added little productive capacity to the economy.

DEMAND VS SUPPLY

But at some point, basic economics kicks back in. When demand - in this case, for credit - exceeds supply, the price goes up. When it comes to money, this means lenders will charge higher interest rates on the money they lend. We seem now to have rounded this bend.

Early this year, the interest rates on government bonds began rising in developed countries. As always, in financial markets, there will be a cyclical ebb and flow to this, but it is likely that the decades-long process of falling interest rates has now ended (How much lower than zero could they have gone, anyhow?).

In recent years, central banks have been pulling out all the stops to keep money cheap by printing as much of it as they can, but this effect now seems to be running its course. And while cheap money did end the Great Recession, it's not clear it tackled the root problems, particularly in Western economies. The BIS's concern is that when the next recession hits, central banks will have no ammunition left to fight it. Because over the next generation, it is likely that interest rates will continue rising. The cost of servicing debt will become more expensive.

Puerto Rico and Greece were thus canaries in a gold mine. As loans become harder to find in the years ahead and the cost of servicing them gobbles up more and more revenue, other dominoes will fall. Nor will the damage be confined to the most vulnerable countries.

China is heavily exposed. The Canadian housing market might implode, tipping that country into recession. US stock markets could yet plummet.

On the other hand, countries that have relatively low debt loads will become increasingly attractive destinations for investment, in no small part because their currencies will remain strong and their financial charges low. By and large, this will tend to tip the balance in favour of developing countries, where private debt is generally much lower than in developed countries. Our governments have sometimes been reckless, but we have behaved surprisingly well.

To avoid going down the Puerto Rican road it is, therefore, imperative that governments not abuse the prudence of their citizens by piling up debt. Whatever debt costs now, it will only get worse with each passing year.

But biting the bullet at what is likely to be a time of economic uncertainty, as the world's markets respond to rising debt costs, will likely pay good dividends for decades to come.

- John Rapley lectures at the Centre of Development Studies at the University of Cambridge. Email feedback to columns@gleanerjm.com.