March 3, 2016 , By BlabberCat

Are you ‘debt-ful’?

Are you ‘debt-ful’?

Terms such as Quantitative Easing and negative interest rates have been recently discussed in our previous articles where it was explained how the central banks throughout the world are trying to increase the supply of money ensuring that banks have more reserves to lend out to people and, in a few countries, the central banks have started penalizing the commercial banks for parking unnecessarily huge reserves with them. Since this whole concept is basically trying to push in more money into the hands of the people, we decided to find out if ‘burdening’ the public with debt is a ‘good option’ to ease out of the turbulent economic times that the world is currently facing. We are just giving you an overall picture here, and have no financial opinions, whatsoever. After all, it’s a democratic country and you should take your own call (at least when it comes to your finances!) – Samreen Akhter

What is debt?

Before going ahead, let us just take a quick look at how debt works. It is a well known fact that when you borrow money from the banks, that is, take a loan, the supply of money in the economy increases. People take loans and spend that money leading everyone to believe that the economy is doing well. However, we have to remember, that since money is created when it is borrowed, there is as much debt in the economy as much as there is money being supplied. Basically, more money = more debt.

What’s wrong here?

It is a well known fact that there was a huge increase in debt in the years leading up to the financial crisis of 2007-08 and, one could say, it set the stage for the oncoming disaster. So it is obvious to wonder how this problem can be solved creating more debt when debt was responsible for it in the first place?! These policies are so far away from standard financial policies that is is obvious to believe that something might be wrong with them.

Cause or solution?

One possibility of introducing these two contemporary weapons is that while QE will be introducing surplus funds into the commercial banks when the central banks make their purchases, the negative interest rates is providing an ‘incentive’ for lending out these excess reserves instead of getting penalized keeping them parked unutilised. The problem here is that for the economy to grow, greater emphasis has to be made on providing loans to the productive parts of the economy that will provide sustainable growth in the long run. This will be further substantiated growth in the household and business income that will push further growth. Growth is going to come not from financial assets but from productive assets that increase income and further help pay off debts, creating more productive ventures simultaneously. Looking at the negative interest rates, it is possible to say that it is nothing but a tax. And, like all taxes, it reduces net financial assets. It is unlikely that this policy will enhance lending activities because banks have other options here such as eating up the losses and passing on these costs to their customers. They are discouraging money flows but not stimulating productive growth in the economy.

What previous experiences have shown?

If we want to get historical at this point, it has been argued that one of the major causes of the Great Depression was debt, in which, the falling prices increased the burden of debt, therecausing further deflation. It has also been observed that calm periods in the economy leads to a careless approach to debt thus, increasing leverage, which then paves way for the disaster to strike. One must also remember that the indebtedness of the private sector in foreign currencies exposes the economy to a vicious circle in which a falling currency causes the value of domestic debts to shoot up leading to economic weakness, ultimately leading to further depreciation.

At the recently concluded G20 Finance Ministers and Central Bank Governors Meeting at the Pudong Shangri-la Hotel in Shanghai, China, it was decided that the world needs to look beyond ultra-low interest rates and printing money schemes to shake off the market uncertainty in recent times. If that is not an indication strong enough, we don’t know what is.

Pics and graphics : Sheejal Maskara

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