economics wealth

Four ways out of a debt crisis

Last week I reviewed Daniel Alpert’s book The Age of Oversupply. Here’s something I picked up from it.

One of the underlying causes of the financial crisis was a huge debt bubble in the Western world. Government, business and ordinary citizens all ramped up debts, taking advantage of cheap money. The finance industry took on more than anyone else, and Britain’s banks have struggled to maintain lending while rebuilding their balance sheets. Business and consumer debt may turn out to be far more of a vulnerability than the government’s debt (with our own currency, government’s have tools that business and households don’t have), and as an economy overall we remain under the shadow of a debt overhang.

How do you get out of a debt crisis? Alpert cites a 2011 report called The Way Forward, which he co-authored with Robert Hockett and Nouriel Roubini, which outlines four possible strategies:

  1. Strong economic growth – if the economy is growing fast, debt repayments are easily affordable and relatively cheaper. But it’s difficult to get growth going if you’re carrying too much debt and nobody wants to borrow more to invest.
  2. Net debt (the balance of assets and liabilities) can be reduced by increasing savings. Unfortunately if everyone cuts spending and saves more at once, growth slows down and the debt becomes unaffordable again.
  3. Inflation can erode the value of debt in real terms. It also pushes up the cost of living and makes savers very unhappy, and it only applies to debts that aren’t tied to the inflation rate.
  4. If you can’t pursue any of the above, the only other way out is to restructure your debts, default or write them off.

Here in Britain, the government has pushed strategy number 2 and hoped for number 1, while quietly crossing their fingers on number 3. Number 4 is the one we don’t talk about, and hope we never have to.

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