Saving takes prudence, discipline, and hard work. Running up the credit card takes none of these things. But that doesn’t mean there aren’t consequences.
Just like an individual, when an entire economy racks up a bill it can’t pay back, future economic growth becomes stunted. It becomes even more difficult to save and invest when more and more earnings must go to service debt. Asian economies are discovering this phenomenon. They are also discovering the relentless hold of a debt trap. What went wrong?
In short, when the financial crisis and Great Recession hit in 2008 nearly all governments ran up their federal debt. The U.S. government, for instance, ran fiscal deficits over $1 trillion dollars from 2009 thru 2012. Since then, they’ve cut budget deficits back to about half of that.
While many Asian governments also increased deficit spending…they never cut back their deficits. They took the massive overruns from the crisis years, which were already a greater percentage of their economy than the United States’ mammoth deficit, and continued to overspend their revenues. The goal was to stimulate the economy through a massive construction boom.
However, it wasn’t just Asian governments that borrowed and spent. Consumers were also enticed by artificially low interest rates to take on greater debt, courtesy of central bank policy. Unfortunately, the public took their central banks’ cheap money bait and are now on the hook for debts they can never pay back. They also hold declining assets, like excess condos, that are now upside down.
Debt Trap Exemplar
Public and private debts in Asian have grown larger than the actual economy can support. The policy of pushing more credit no longer works. At some point, borrowers disappear regardless of how far interest rates are pushed down. The public becomes repelled by it.
“Growth is slowing fast across the continent as consumers and businesses focus on repaying debt,” reports the Wall Street Journal. “Central banks have cut rates, pushing currencies lower, but economies haven’t picked up. Demand has stayed weak, keeping wages stagnant and price growth anemic, making borrowings even harder to repay.
“This dynamic could significantly harm the region’s economic prospects, potentially dragging down global growth rates.
‘“The problem is people already have taken on too much debt,’ says Paul Sheard, chief global economist for Standard & Poor’s Ratings Services. ‘Even if you cut interest rates to zero, people are not going to borrow money.”’
The debt load’s become too burdensome. Greater amounts of production are being diverted from consumption to repaying debt. The decline in demand results in a decline in economic activity, which, in turn, makes repaying the debt even more difficult.
The Fastest Way to Escape a Debt Trap
Yesterday’s stimulus enticed people to borrow from the future. The initial growth from the credit binge had the consequence of reducing today’s growth. Yet policy makers want to fix the problem of too much debt by adding more debt. It’s all they know how to do.
In China, the government also had a lender of last resort policy. They’d offer last minute loans when a large corporation was on the verge of default. While this kept dying business on life support, it also created a massive moral hazard…it became implied the government would always prop up failing companies. But that appears to be changing…
“Already this week, property developer Kaisa, and state-owned Baoding Tianwei Group, a power transformer manufacturer, have failed to make payments to creditors,” reports CNN Money. “No bailouts have materialized.
“And that’s a really good thing.
“Beijing has been gradually rolling back the implicit guarantees that underpin China’s financial system. Last year, bondholders were given a fright when Chaori Solar was allowed to miss a payment, becoming the first Chinese corporate to default.”
This could be the tip of the iceberg for Chinese defaults. But, over time, it will help put the economy on a healthier footing. Though harsh. Though painful. The fastest way to escape a debt trap is not through bailouts. Nor is it through renegotiated loan terms…
Rather, it’s through good ol’ fashioned, honest to goodness default. It works every time.
for Economic Prism