Repent on leisure

History of Debt from 1980s to present

Throughout the 1980s and 1990s a rise in debt levels accompanied what economists called the "great moderation", when growth was steady and unemployment and inflation remained low.

By the early 2000s a vast international scheme of vendor financing had been created. China and the oil exporters amassed current-account surpluses and lent the money back to the developed world so it could keep buying their goods.

After all, asset prices were rising even faster, so balance-sheets looked healthy. And with the economy buoyant, debtors could afford to meet their interest payments without defaulting. In short, it paid to borrow and it paid to lend

The problem of Debt

Like alcohol, a debt boom tends to induce euphoria. Traders and investors saw the asset-price rises it brought with as proof of their brilliance; central banks and governments thought that rising markets and higher tax revenues attested to the soundness of their policies.

The answer to all problems seemed to be more debt.

Debt increased at every level, from consumer to companies to banks to whole countries.

(Data) Debt as % of GDP, 2008

Can we stop the debt super cycle?

Why debt may have become a burden rather than a boon?

1)     Why do people, companies and countries borrow?

Borrowing is the only way they can maintain their desired level of spending.

Optimism; they believe the return on the borrowed money will be greater than the cost of servicing the debt.

Answer) But in parts of the rich world such optimism may now be misplaced.

With ageing populations and shrinking workforces, their economies may grow more slowly than they have done in the past. They may have borrowed from the future, using debt to enjoy a standard of living that is unsustainable.

Greece provides a start example. S&P, a rating agency, estimates that its GDP will not regain its 2008 level until 2017.

Rising government debt is a Ponzi scheme that requires an ever-growing population to assume the burden

Sovereign default is far from inconceivable.

Ex) Greece

Ex) Country with national debt reached certain level.

Debt is often treated as a moral issue as well as an economic one.

Borrowers' side of moral

 

MOVING MORALS

In the past 10 years the moral battle has moved in favor of the debtors. Bankruptcy is no longer stigmatized but simply regarded as bad luck.

When consumers borrow beyond their means, the blamed is laid on lax lending practices rather than irresponsible borrowing.

Government have encouraged more people to become homeowners and thus to take on debt.

In business, a few failed directorships are a sign of entrepreneurship rather than incompetence.

The recent crisis has also diminished belief in the judgement of the financial markets. The role of banks in the credit crunch and the cost of financial sector bail-out has undermined the idea that the markets assess risk fairly and rationally. Instead, higher borrowing costs are seen as the result of unscrupulous speculation.

The role of sovereign credit-default swaps (CDS), a way of betting on the likelihood of a country's failure to repay the money it has borrowed, has proved particularly controversial.      

WHY IT MATTERS?

1)     The problem with debt, though, is the need to repay it.

This is particularly troublesome if the economy slips into deflation, as happed globally in the 1930s and in Japan in the 1990s. Debt levels are fixed in nominal terms whreas asset prices can go up or down. So falling prices create a spiral in which assets are sold off to repay debts, triggering further price falls and further sales. Irving Fisher, and economist who worked in the first half of the 20^th century, called the debt deflation trap.  

2)     Another reason why debt matters is to do with the role of banks in the economy.

By their nature, banks borrow short( from depositors or the whole sales markets) and lend long. The business depends on confidence; no bank can survive if its depositors (or its wholesale lenders) all want their money back at once. If banks struggle to meet their own debts, they have no choice but to reduce their lending. If this happens on a large scale, as it did in the 1930s, the ripple effect for the economy as a whole can be devastating.

Both of these effects were seen in the debt crisis of 2007-2008. Falling property prices caused defaults and a liquidity crisis in the banking system so severe that the authorities feared the cash machines would stop working. Hence the unprecedented largesse of the bank bail-out.

Hyman Minsky, an American economist who has become more fashionable since his death in 2996, argued that these debt crises were both inherent in the capitalist system and cyclical. Prosperous times encouraged individuals and companies to take on more risk, meaning more debt. Initially such speculation is successful and encourages others to follow suit;

In the aftermath of the latest collapse it is clear that the distinction between debt in the private and public sector has become blurred. If the private sector suffers, the public sector may be forced to step in and assume, or guarantee, the debt, as happened in 2008. Otherwise the economy may suffer a deep recession which will cut the tax revenues governments need to service their own debt.

 

 

The debt-financed model has reached its limit. Most of the options for dealing with the debt overhang are unpalatable. As has already been seen in Greece and Ireland, each government will have to find its own way of reducing the burden. The battle between borrowers and creditors may be the defining struggle of the next generation.