Global Debt Spooks Stocks -- by Jerry Jasinowski

Stocks around the world continue their slide and the root cause is a global debt crisis that threatens to unravel. The proportions of the debt burden are eye-popping. "The world's dollar-denominated debt, a lot of it held by emerging market economies, is said to exceed $19 trillion," said David Smick, founder and editor of The International Economy.

The biggest debt sinkhole of all is China which has fueled its robust growth with easy credit. China's financial sector will have loans and other financial assets of $30 trillion by the end of this year, up from $9 trillion seven years ago, according to Charlene Chu, an analyst in Hong Kong for Autonomous Research. "The world has never seen growth of this magnitude over such a short time," she said. "We believe it has directly or indirectly impacted nearly every asset price in the world, which is why the market is so jittery about the idea that credit problems in China could unravel."

Economic distortions driven by investment "bubbles" have contributed to the debt overhang. The challenge is to recognize that overhang and deal with it. We are making progress cleaning up the debt hangover left by the U.S. housing bubble. But elsewhere the wisdom and political courage required to deal with excessive debt is less clear. Banks in Europe are saddled with more than $1 trillion in bad loans but the existence of a common currency absent a coherent political structure makes it difficult for the EU to make the hard decisions required to deal with it. Runaway debt is also undermining Brazil and many other emerging economies.

The Federal Reserve is at least partially responsible for precipitating this crisis. By raising interest rates, it drives up the dollar which makes that $19 trillion in dollar denominated debt that much harder to deal with, slowing growth and putting pressure on debtor nations to devalue their currencies. Even China is vulnerable. Not so long ago we all assumed China's finances were solid because it was sitting on a huge pile of foreign currency which peaked in 2014 at nearly $4 trillion. But now China is burning through that pile in a frantic effort to prop up its financial markets. It drew down $107.9 billion in December and another $99.5 billion in January. The stockpile is now down to $3.23 trillion. That won't last long at the current rate of drawdown. Eventually China will have little choice but to massively devalue its currency.

Therein lies the core threat to a lopsided world economy with too much capital chasing too little consumer demand. Devaluation of China's currency will inevitably spark an overt international currency war as other nations devalue their own currencies in a frantic effort to boost exports. "So a demand short industrial world is likely to confront an emerging market sector that is shifting toward much more capital outflow, much less ability to receive investment, and much more depreciated exchange rates," said former Treasury Secretary Larry Summers. "That raises the risk of a cycle where emerging markets pull the industrial world down and, in turn, the industrial world pulls emerging markets down."

It may turn out that the Fed's modest hike in interest rates was the proverbial straw that broke the camel's back and tipped the world into a major financial crisis.

Jerry Jasinowski, an economist and author, served as President of the National Association of Manufacturers for 14 years and later The Manufacturing Institute. Jerry is available for speaking engagements. February 2016