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Higher debt with lower growth a 'poisonous combination,' Geneva Report says

Buildings are seen in the financial district in Toronto, January 28, 2013. REUTERS/Mark Blinch

Interest rates will have to stay low for a long time or the world economy could crumble under mounting debt loads, an influential report written by three former central bankers says.

The 16th annual Geneva Report, an influential paper published by a panel of economists including three former central bankers, said Monday that interest rates will have to stay low for a "very, very long" time to let people, companies and governments pay down their ballooning debt loads, or the world could be thrown into another financial crisis.

The report was authored by professor Philip Lane of Dublin’s Trinity College, professor Lucrezia Reichlin of the London Business School, Luigi Buttiglione from Brevan Howard investment products and Vincent Reinhart from the American Enterprise Institute.

They say the new reality of slower economic growth, which brings with it lower-than-expected inflation, is creating a "poisonous combination" that threatens the global economy.

Many recent data points from Canada suggest households are slowly attempting to borrow less, paying down their debt loads in the current low rate environment. But there's ample evidence to suggest that corporations aren't taking real steps to pay down debt, with most being eager to borrow cheap money to buy back their own stock, which gives stock prices a bump and triggers executive bonuses for getting the stock price to go higher.

And governments in the West might be talking about reducing debt loads in some distant period down the line. But in real terms, they're borrowing more and more while it's cheap to do so.

Indeed, Canada's federal government says it's on track to reduce its annual deficit next fiscal year. But the national debt is still growing by about $7 million per day, and currently sits at $620 billion, the Canadian Taxpayer's Federation says.

Overall, the world's total debt load has risen from 160 per cent of national income in 2001 to almost 200 per cent after the crisis struck in 2009.

But contrary to all the talk of "deleveraging" that ratio has actually increased since the financial crisis, and was up to 215 per cent globally last year. Put another way, the world owed a collective $70 trillion US before the last recession. But today that figure is up to $100 trillion.

"Contrary to widely held beliefs, the world has not yet begun to delever and the global debt to GDP ratio is still growing, breaking new highs," the report reads.

Developed economies such as Canada's and other G20 nations used to lead the way in increasing their debt loads. But now it's emerging markets that pose the biggest risk, especially China and a group the paper calls the "fragile eight" — Argentina, Brazil, Chile, India, Indonesia, Russia, South Africa and Turkey.

Right now, the global economy is in a "vicious loop" the report warns, where low interest rates are what's needed to dig out of debt. But it's those low rates that helped caused the debt bubble in the first place.

"In such a context, and with still very high leverage, allowing the real rate to rise above its natural level would risk killing the recovery" the report reads.

The Federal Reserve is widely expected to start ratcheting its benchmark interest rates higher some time next summer. Other central banks are expected to follow suit either just before or just after the Fed moves.

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