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Debt Is Piling Up: So What?

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Debt is piling up worldwide. But so what?

We have described increasing levels of US debt as a “ticking debt bomb.” American families have amassed more than $1 trillion in credit card debt alone. As of the end of 2016, the average credit card debt per American household stood at $8,377. That was up from $7,893 at the end of 2015.

Of course, credit card debt makes up just one portion of US consumer indebtedness. You also have to factor auto loans and student loans into the mix. In February, total consumer credit stood at $3.79 trillion. The annual growth rate of total consumer debt is pushing 5%.

Everyday Americans aren’t the only ones racking up debt. They are simply following the example of their Uncle Sam. The US national debt is pushing $20 trillion, with actual unfunded liabilities pushing far higher.

America isn’t alone. Debt is a worldwide phenomenon. Just last week, Moody’s downgraded China’s credit rating. It estimates the Chinese government’s debt burden will rise to near 40% of GDP by 2018 and 45% by the end of the decade.

Meanwhile in England, policymakers have expressed concern at rising credit card debt. According to the Financial Times of London, the level of outstanding debt on credit cards has now reached record levels in the UK, approaching £68 billion.

Now you might be asking yourself, so what? As long as people are keeping up with the payments, does all of this debt really matter?

I have two words for you.

Central banks.

The Fed wants to raise interest rates. What happens when they do? The cost of servicing all of that debt increases. And even a small increase can mean a big jump in loan payments when you have large debt levels.

Let’s use an extreme example. Let’s say you borrow $1 billion at 0% interest. Initially, you’re not paying any interest at all. Good deal! As long as your income stays stable, you won’t have any problem making your payments. But tomorrow the lender demands 0.1% interest. You will now have an annual interest bill of $1 million.

Uh oh.

Now think an interest rate increase in the context of the US federal government debt. How much of America’s GDP will it take to service all that debt if the Fed pushes rate up to even 2 or 3%?

Bigger uh oh.

Since 2008, the Fed, and central banks around the world, have held interest rates at close to zero – even taking them negative in Europe and Japan. The goal was to get consumers spending and businesses borrowing in order to “prime the pump” and jump-start the economy. It’s worked. People, businesses, and governments have all taken advantage of low interest rates and borrowed lots of money. But now the central banks need to “normalize.” That means a lot of people are going to have to pay the piper.

The Fed keeps saying it plans to move ahead with rate hikes. On the other hand, the European Central Bank appears committed to maintaining low interest rates and quantitative easing schemes for at least the rest of the year. As we put it yesterday, it looks like the central banks are on divergent paths to doom.

No matter what the central banks do, the debt bubble is simply unsustainable. Policymakers may be able to keep it inflated for a while, but it will deflate. When it does, it won’t be pretty.

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