Debts should come with a serious economic health warning!

De Koning, Kees (2015): Debts should come with a serious economic health warning!

Abstract

The transfer of savings from one household to another creates a financial relationship between these households. Nearly always conditions of reward and repayment are attached to such a transfer. In a world where savings have grown to a multiple of annual economic output, the chances that debts can cause economic stagnation and major unemployment situations have risen strongly. This can both be on a national as well as on an international level.

Debts can help households and governments to increase their spending power, but there is always a “cost”. Future income levels are needed to repay the debts. What is surprising is that economists have had such great difficulty in predicting when debts turn from a sound base into a threat to economic growth levels. Waiting till a crash happens as in 2007-2008 does not seem to be a very sensible manner in running an economy. What is also surprising is how little power individual households have over the level of debts for which they carry the ultimate repayment responsibility, including government debt levels.

Growing debt levels need to be analyzed extensively; but studying developments is not enough if brakes cannot or are not applied to stem a rapid growth in debt accumulation.

Furthermore the structure of adding to debt levels has to be studied. The collective of banks rather than an individual bank in the U.S. created the home mortgage lending boom in the run up to 2007. Capital markets assisted in funding such loans. Democratically elected governments can authorize excess levels of borrowings, which can bring the economy of a whole country down. The extensive use of debt funding for company mergers and acquisitions is another example of loading more debt to the company sector, which can cause further economic disruptions. Finally the international use of especially the U.S. dollar for borrowing purposes may pose its own threat to international economic growth levels.

This paper focuses on the U.S. situation, especially from 1997 to today. This paper will conclude that the “debt problem” started with U.S. individual households in taking up excessive mortgages from as early as 1998. Alarm bells should have started ringing in 2002, when the mortgage debt allocations between building new homes and pushing up home prices in excess of income growth shifted to the latter. In 2002 62% of new funds was used for funding house price increases in excess of income growth. This trend continued all the way to 2007.

Another conclusion is that the U.S. government debt problems accelerated from 2009 onwards. It seems that the drop in taxes received was the main cause of the increased debt levels. Government debt problems followed the home mortgage crash.

The cash injections from central banks after 2008 added to the world savings levels, which were already at high levels. The financial crisis of 2007-2008 was a finance-induced crisis. It was different from the oil price crisis of 1973, which caused savings to flow to oil-producing nations.

• Item Type: MPRA Paper
• Language: English
• Keywords: debt crisis; danger points, banking profits, lending volumes compared to income growth, U.S. case study on home mortgages 1998-2015
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E41 - Demand for Money; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies

References

• The International Monetary Fund: IMF Survey Magazine: Policy; April 8 2015 Global Financial Stability Report: Plain vanilla investment funds can pose risks;

• Federal Reserve Bank of St. Louis, B100 and B101 Balance Sheet of Households and Non-profit Organizations, Quarterly and annual publication;

• The evil force of borrowing and the weakness of Quantitative Easing by Drs Kees De Koning, 7 February 2015 http://mpra.ub.uni-muenchen.de/61970/

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