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Is a global debt crisis coming? | CNBC Explains - YouTube
Channel: CNBC International
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Total worldwide debt has never been higher.
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And yet, there's little sign of this current wave
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retreating any time soon.
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Now with the coronavirus outbreak being declared
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a pandemic, governments have announced hundreds
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of billions of dollars in stimulus packages
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that will send debt even higher.
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So, just how worried should we be if it all
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comes crashing down?
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Global borrowing has been growing rapidly,
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so rapidly that many are concerned it is quickly
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becoming unsustainable.
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The Institute of International Finance estimates
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total worldwide debt, which is made up of
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borrowings from households, companies and
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government, surged to a staggering $253 trillion
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at the end of September 2019.
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That’s a whole lot of debt, more than three times
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the annual economic output of the entire world.
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It works out to roughly $32,500 of debt
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for each of the 7.7 billion people on the planet.
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What’s more, the group says this figure
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is only going to increase.
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The World Bank believes the speed
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and scale of this debt wave
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is something we should all be worried about.
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So much so, the group has urged governments
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around the world to make it a primary concern.
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But let's take it a step back.
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Put simply, debt is created when one party
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borrows from another.
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It allows individuals to buy something they
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wouldn’t normally be able to afford.
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That has its benefits.
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For example, you might take on debt when you
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get a loan to buy a car or mortgage on a house.
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This allows you to pay back the cost of those
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investments over time instead of all at once.
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The cost of this service is the interest rate.
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At present, interest rates around the world
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have fallen to historically low levels.
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This has made it cheap to borrow from banks,
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meaning businesses can make large investments
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and homeowners don’t need to spend as much
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on their monthly mortgage payments.
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There are drawbacks to a low-rate environment though.
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Individuals aren't likely to see much of a
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return on their savings, and both people and
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businesses could load up on too much cheap
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debt, something we’re seeing now.
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Governments take on debt too, which they can
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use to stimulate the economy by funding infrastructure
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projects, social programs and more.
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How much a country’s government owes is
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known as sovereign debt.
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Sovereign debt is very different to how we
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might think about debt as an individual.
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But, one thing they both have in common
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is that problems tend to arise
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when that borrowing becomes excessive.
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Loans to countries with developed economies,
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like Canada, Denmark or Singapore, are generally
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seen as safe investments.
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That’s because even if governments spend
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beyond their means, lawmakers can raise taxes
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or print more money to ensure they
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pay back what they owe.
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But loans to governments in emerging markets
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are generally seen as much riskier, which
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is why these countries will sometimes issue
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debt in a foreign, more stable, currency.
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Although this allows them to attract more
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investors from abroad looking for bigger returns,
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an economic slump, weak home currency or a
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high debt burden can make it difficult for
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the government to pay them back.
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Ultimately, the most important risk when it
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comes to national borrowing is
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that a country may fall behind on its debt
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obligations and default.
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This isn’t common but it has happened.
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Take Lebanon in 2020, Argentina in 2001
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and Russia in 1998.
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Over the last 50 years, there have been four
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waves of debt accumulation.
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We are currently in the midst of the fourth wave.
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So, what can we learn from the first three?
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Well for one, none of them had a happy ending.
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Let’s start with the first wave.
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In the 1970s, many Latin American countries
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began to borrow extensive amounts of money
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from U.S. commercial banks and other creditors
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to support their development.
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It didn’t seem like a problem at the time.
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Interest rates were low, and Latin American
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economies were flourishing.
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But in the background, the debt wave was rising.
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At the end of 1970, the region’s total outstanding
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debt from all sources added up to $29 billion.
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By the end of 1978, that number had shot up
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to $159 billion.
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Four years later, it had more than doubled
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to $327 billion.
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In the 80s, major economies began
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hiking up their interest rates as they battled inflation.
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Oil prices were sliding, and the world economy
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was entering a recession.
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In 1982, the starting gun of the Latin American debt crisis
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was effectively fired, when Mexico announced
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it would not be able to service its debts.
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This move quickly sparked a meltdown
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across the region, with the fallout spreading to
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dozens of emerging economies worldwide.
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Many countries in Latin America were forced to devalue
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their currencies to keep exporting industries competitive
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in the face of a sharp economic downturn.
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Between 1981 and 1983,
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Argentina weakened its currency against the U.S. dollar
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by 40%, Mexico by 33% and Brazil by 20%.
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Ultimately, 27 countries had to restructure their debts.
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Sixteen of them were in Latin America.
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The second wave ran from 1990
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through to the early 2000s.
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It was unlike the first in that
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debt accumulation in the private sector
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played a much more prominent role.
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In the late 80s and early 90s, many advanced
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economies deregulated their financial markets.
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The policy changes led to many banks consolidating,
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and these bigger banks operations became
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increasingly global.
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This helped prompt a massive surge of capital
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into emerging markets, with falling interest
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rates and a slowdown in advanced economies
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also fueling the surge.
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Developing economies began to rack up a lot of debt,
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most notably Indonesia, South Korea,
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Malaysia, the Philippines and Thailand.
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Yet this growing wave of debt went largely
unnoticed.
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You see, debt was growing rapidly, but so was GDP,
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meaning the ratio between the two stayed consistent.
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And most of the debt was hidden in the private sector.
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A currency crisis in Mexico in 1994
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thrust international investors back into panic-mode,
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with the country’s default a decade earlier
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still fresh in people’s minds.
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Yet, while a $50 billion bailout from the U.S.
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and the IMF meant Mexico was narrowly
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able to avoid a default this time around,
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it wasn't enough to stop panic spreading to
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other countries.
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It led to an abrupt stop and reversal
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of capital flows in 1997.
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By this point, Indonesia, South Korea, Malaysia,
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the Philippines and Thailand had developed
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a dependence on borrowing.
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Coupled with several policy failings, this helped usher in
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a crisis in East Asia's financial sector
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and, ultimately, another global downturn.
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While those impacted by the Asian financial crisis
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recovered, international borrowing carried on
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at a brisk pace.
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Enter the third global debt wave,
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which lasted from 2002-2009.
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At the end of the previous century, the United States
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removed barriers between commercial and investment banks,
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while the European Union encouraged cross-border connections
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between lenders.
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This paved the way for the formation of
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so-called ‘mega-banks.’
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These banks led the way in a sharp increase
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in private sector borrowing, particularly
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in Europe and Central Asia.
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Defaults in the U.S. sub-prime mortgage system
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piled more and more pressure on the country’s
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financial system, pushing it to the brink of collapse
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in the second half of 2007 and 2008.
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The shockwaves reverberated across the world,
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with one economy after another falling into
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a deep, albeit short-lived, recession.
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In the U.S., the 2009 recession was so severe
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that output from the world’s largest economy
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sank to its lowest level since the Great Depression.
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The World Bank says we are currently in the midst
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of the fourth wave of global debt.
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And to avoid history repeating itself yet again,
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governments must make debt management
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and transparency a top priority.
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This wave of global debt is thought to share many
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of the same characteristics as the previous three,
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including prolonged periods of low
interest rates
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and changing financial landscapes
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which encourage more borrowing.
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But the World Bank has called the current
wave
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“the largest, fastest and most broad-based" of them all.
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It involves a concurrent buildup of both public
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and private debt, involves new types of creditors
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and is much more global.
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However, as the coronavirus pandemic
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threatens to sink the world economy,
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the moment for stemming the tide may have passed.
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