Author's Note : It would be cynical to point out the difference in the levels of debt now compared to when this was written.

Oct 08

Posted in: Economics Posted by: P S Billimoria

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What’s Going Wrong Here?

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It may only be my imagination but each time I saw the “debt clock” in New York City it appeared to be notching up numbers faster than before. Now it has been reported that the clock had stopped because it ran out of digits! Small wonder then, that in 21 years of dealing with American businesses I have never seen them as nervous and unsure then at this present moment. That country’s national debt is now in excess of a mind boggling 10 trillion dollars. And in very much the same way as personal debt is a burden for the children of the family, national debt means that future generations of Americans may have to pay for the excesses of the last 15 years.

Pretty much anything at the macro level can be understood in terms of the microcosm of a household. So consider a family burdened with debt and trying to stay afloat. If the household income is not sufficient to meet loan repayments, then it may be forced to reduce spending. This means not just scrimping and scrounging but also postponing necessary acquisitions of assets. So, for example, the family may have to defer buying a new car even though the old one breaks down frequently. In national terms this could translate into higher taxes, creaky infrastructure and lower standards of health care and other forms of social security. Where a Government differs from families however, is in its ability to pursue deficit financing, which is only a fancy term for printing more currency. That however, results in inflation and if there is anything worse then recession it is a recession combined with inflation. That’s a nightmare scenario where not only are people losing jobs but it is combined with even items of basic sustenance becoming increasingly unaffordable.

It doesn’t have to be that way of course. For instance if the hypothetical family could find some way to increase its income then with a little belt tightening it may well be able to maintain living standards and manage loan repayments at the same time. But income levels have the potential to increase only if the economy is on the growth path. For the last two decades economists have thought that this growth ought to be axiomatic, given the advent of the internet (and the consequential expansion of the marketplace due to e-commerce) and productivity gains from new technologies. Unfortunately, these economists were right and wrong at the same time. They were right in that the productivity did improve year on year, the markets did expand and the world had an unprecedented run of prosperity. However, what everyone missed is that the increase in debt and deficits was higher than the increase in productivity. To understand this let us return to the example of our household. We know that if the family can increase income they could maintain their lifestyle and also pay down their debt. But what if their debt repayment obligations kept increasing and also increased faster than their household income? At some point, something has to give.

If you are wondering why the yanks got themselves into this lockjam, the cause is evident to the silent observer. One thing you notice very quickly when you are in North America is that people have no personal liquidity. Spending money and loose cash are rare while a rectangular piece of plastic is the lifeline. Credit cards were meant to ease the need to carry around bundles of cash and were predicated on the belief that most responsible people will settle their bills regularly. However, at some point it became a way for Americans to spend more than they could afford. Few can resist buying a good time by mortgaging future (and sometimes anticipated but uncertain) income. And if this is part of the national character then blame the buffoons running the country. Successive administrations exhorted people to go out and shop in the simplistic belief that building demand is the right way to grow the economy. But what if the demand is based on unsustainable borrowings? Well, then what we will have is a bubble and like all bubbles, it must burst one day. And it has.

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