While borrowing money and spending it can feel exhilarating, it often pales in comparison to the necessity of saving and paying off debt. The allure of easy credit far outweighs the discipline required for responsible financial management.
Saving money demands careful planning, self-control, and diligence. On the other hand, racking up credit card debt requires none of these qualities. However, it’s important to recognize that there are significant consequences to excessive borrowing.
When an economy accumulates debt it cannot repay, the repercussions are felt broadly, leading to stunted economic growth. With an increasing portion of income directed toward servicing debt, the ability to save and invest diminishes. Many Asian economies are currently grappling with this issue, revealing the daunting grip of a debt trap. What led to this predicament?
In the aftermath of the financial crisis and Great Recession of 2008, governments around the globe significantly increased their federal debt. For instance, the U.S. government ran fiscal deficits of over $1 trillion from 2009 to 2012, before eventually reducing deficits to about half that amount.
Unlike the U.S., many Asian governments failed to cut back on their deficit spending after the crisis. They carried over substantial deficits from those years, which were already at a larger percentage of their economies compared to the United States, and continued with this overspending strategy in an attempt to stimulate growth through a construction boom.
However, the borrowing spree was not limited to governments alone. Consumers were also lured into taking on additional debt, thanks to the central banks’ policy of maintaining artificially low interest rates. Unfortunately, individuals took the bait, accumulating debts that are now unmanageable, along with depreciating assets such as unsold condominiums.
The Debt Trap Dilemma
In Asia, public and private debts have escalated to levels that exceed the capacity of their economies. The traditional method of pushing more credit has lost its effectiveness, as there comes a point when borrowers become disinterested, regardless of how low interest rates drop.
As reported by the Wall Street Journal, “Growth is slowing fast across the continent as consumers and businesses focus on repaying debt.” Central banks have lowered interest rates and devalued currencies, yet economic recovery has remained elusive. Weak demand has kept wages stagnant and price growth minimal, further complicating repayment efforts.
“This dynamic could significantly harm the region’s economic prospects, potentially dragging down global growth rates,” the report warns.
Paul Sheard, chief global economist for Standard & Poor’s Ratings Services, adds, “The problem is people already have taken on too much debt. Even if you cut interest rates to zero, people are not going to borrow money.” The burden of debt has become overwhelming, diverting resources away from consumption and into debt repayment. As demand wanes, economic activity contracts, making it even harder for individuals to manage their debts.
A Path Out of the Debt Trap
The earlier economic stimulus encouraged individuals to borrow against future earnings, initially fostering growth but ultimately leading to diminished growth in the present. Yet policymakers continue to pursue solutions that involve increasing debt, a strategy they are all too familiar with.
In China, the government has historically acted as a lender of last resort, providing last-minute loans to corporations on the brink of default. While this approach kept failing businesses afloat, it also created significant moral hazard, leading to the perception that the government would always bail out struggling companies. This trend seems to be shifting.
As reported by CNN Money, “Already this week, property developer Kaisa, and state-owned Baoding Tianwei Group, a power transformer manufacturer, have failed to make payments to creditors.” No bailouts have emerged.
This trend may be a harbinger of further defaults in China, but it could ultimately lead to a more sound economic foundation. Although the process may be difficult and painful, the fastest way to escape a debt trap is not through bailouts or renegotiated loan terms. Instead, the most effective solution lies in the honesty of default, which has proven effective every time.
Sincerely,
MN Gordon
for Economic Prism
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