The over-indebted American consumer will be hard pressed to simultaneously reduce debt and maintain levels of consumption that support economic growth. On CNBC today, Stephen Roach of Morgan Stanley says, we need “ways to forgive the excesses of mortgage, installment and revolving credit, as what was done in the 1930s, that will help consumers get through the pain of deleveraging sooner rather than later.”
There are four ways to reduce real debt burdens:
- by paying down debts via accumulated savings.
- by inflating away the value of money.
- by reneging in part or full on the promise to repay by defaulting
- by reneging in part on the promise to repay through debt forgiveness
Listening to Roach explain the conundrum of high unemployment and poor wage gains, juxtaposed with high debt, it is clear he recognizes there is zero chance that consumers will be able to support the kind of economic growth via deleveraging and accumulating savings that avoids a deflationary outcome. The macro backdrop for consumers is deflationary.
Central banks or fiscal agents might attempt to reduce the real burden of debt. Look at the UK where financial repression is the most advanced in the developed economies and the Bank of England has missed its inflation target time and again. The consumer there is in a world of pain. UK household finances are ‘worse than during height of recession’.
However, if we see another recession before the deleveraging is complete – as is my base case – deflation is going to be all around us, increasing the real burden of debt. In my view high levels of default or debt forgiveness are likely going forward in the US, Ireland, the UK, and Spain at a minimum.
The Roach video is below.