A false sense of global security? Follow the debt to the next financial crisis.

• Author: Lachman, Desmond

In the 1976 movie All the President's Men, Washington Post reporters Bob Woodward and Carl Bernstein were advised to follow the money if they wanted to find the real source of the Watergate cover-up. One has to wonder whether something similar might not be said about the next global financial crisis. If one wants to determine the next such crisis, one might be well advised to follow the debt, since normally, the primary source of financial and economic crises is over-indebtedness in the economy.

Following the debt today should dispel any complacency about the world economic outlook. According to a recent McKinsey study, in the seven years since the bursting of a global credit bubble that resulted in the worst world financial crisis since the Great Depression, overall global debt has increased by around US$60 trillion, or by some 17 percentage points of global GDP. As a result, rather than reducing indebtedness, today practically all of the world's major economies have higher levels of overall borrowing relative to GDP than they did in 2007.

Of particular concern has to be the over-indebtedness in key regions of the global economy. Among the more vulnerable of these regions is the formerly rapidly growing emerging market economies, which went on a borrowing binge in the up phase of the international commodity price cycle. These economies now account for around 40 percent of world GDP and until very recently were the major engine of global economic growth. Since 2008, corporate indebtedness of the emerging market economies has more than doubled to around US$23 trillion. This makes that debt market approximately the same size as the U.S. high-yield debt market, which underlines its potential to destabilize global financial markets.

More troubling yet, as the Bank for International Settlements keeps reminding us, is the fact that over the past seven years, these emerging market corporations have increased their U.S. dollar-denominated indebtedness by over US$3.25 trillion. This makes the emerging market economies particularly vulnerable to crises, especially at a time when their currencies have plummeted and they are being hit hard by a major international

commodity price bust. It also does not help matters that a number of key emerging market countries such as Brazil and Russia are in the grips of very deep economic recessions.

It also has to be of major concern that non-financial enterprises in China, the world's second-largest economy, have...