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The US Federal Reserve building. (Reuters/Yonhap)

Moody’s downgraded the credit ratings of several smaller US banks, in a move that followed on the heels of the global credit rating agency Fitch’s first downgrade of the US national credit rating in 12 years.

The common denominator was liabilities. While governance risk was a factor in Fitch’s unusual credit rating downgrade — namely the down-to-the-wire debt ceiling negotiations between Republicans and Democrats over the past 20 years — it was fundamentally a matter of increasing US government debt.

The US government’s enormous fiscal expenditures on pandemic recovery and reshoring policies have translated into a steady rise in debt. Fitch predicted that the ratio of government debt to gross domestic product (GDP) would rise from 112.9% this year to 118.4% by 2025. The US Congressional Budget Office came out with an ultra-long-term projection that US government debt could reach as high as 180% of GDP by 2050.

The liability risk is visible not only with the government but also with households and smaller banks, as witnessed with the Silicon Valley Bank collapse.

According to the Federal Reserve Bank of New York, Americans’ credit card debt stood at US$1.03 trillion as of the end of the second quarter, while student loan balances — which borrowers are scheduled to begin repaying again this autumn — totaled US$1.57 trillion. Another latent risk factor is commercial real estate underperformance, which has been the focus of ongoing danger predictions.

With the US Federal Reserve still in a cycle of interest rate hikes, the currently high interest rates appear very likely to remain in place for some time. In that sense, the bills for US liabilities have already started arriving.

It isn’t only the US that is seeing its liabilities getting called in. South Korea, Japan and China are also exposed to debt risks, as their government liabilities increased substantially during the pandemic.

As the debt risks become a reality in China, observers are increasingly warning of a long-term balance sheet recession along Japanese lines. If central and local government liabilities are combined with unreported “shadow debt,” the scale of China’s government debt is believed to exceed 100% of GDP.

With the Chinese economy already facing massive corporate liabilities, repayment requests for its government debt stand to pose a major risk not only to China’s economy but the global economy as a whole. Already, a string of defaults — especially by real estate developers — has been sending warning signs of debt risk.

The debt issue is also drawing new attention in South Korea. In particular, it has recently been facing a troubling phenomenon where household debt has risen sharply in tandem with growing government debt.

As of late July, the household loan balance in South Korea stood at an all-time high of 1.068 quadrillion won (US$803 billion). The amount itself is problematic — but an even bigger issue is the recent rise in the rate of increase in liabilities.

In July, household bank loans rose by 6 trillion won compared with the month before, the largest increase since September 2021. This suggests a return to conditions that year, which witnessed what was referred to as the “yeongkkeul” (betting every penny) phenomenon of people investing to take advantage of an ultra-low 0.5% benchmark interest rate.

There’s no such thing as a free lunch, and the fast-rising debt burden is very likely to boomerang back. The Bank of Korea is not in a position to lower interest rates any time soon, particularly if the US Fed maintains the current policy interest rate level.

It is quite apparent that the volume of repayment requests will continue to grow. With South Korea facing simultaneous rises in household, corporate, and government debt — along with the additional debt risk posed by real estate project financing — it would not be overstating things to conclude that it is sitting on a veritable mountain of liabilities.

It might be able to repay them well enough if the business cycle recovered, but the global business situation is far from encouraging. If the Chinese economy suffers a hard landing with its debt risk, that risk is very likely to have negative ripple effects for South Korea’s debt risk. This could leave the South Korean economy facing a perfect storm in terms of liabilities.

It’s time for us to make solid preparations for the repayment requests to come.

By Park Sang-hyun, analyst at Hi Investment & Securities

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