The Recovery’s Silent Assassin: How Debt Deleveraging Killed the Economy – Harris Collingwood – Business – The Atlantic

Millions of Americans are taking similar steps. Some 8 million U.S. consumers stopped using bank-issued credit cards in 2010, according to the credit-reporting agency TransUnion. The average credit-card balance has fallen 10 percent this year from 2010, to $6,472; U.S. consumer debt has dropped for 12 consecutive quarters, from a peak of $14 trillion in early 2008 to $13.3 trillion last spring, mainly because of mortgages repudiated or abandoned. People are cutting visits to the hairdresser, buying used cars without financing, and living on surplus cheese as they trudge toward the promised land of a debt-free existence.

Ponder what economists call the paradox of deleveraging. This occurs when economic actors on all sides–consumers, business, government–all retire their debts at once. Unless their incomes are rising, they can pay off debt only by cutting what they spend. This, in turn, reduces the demand for goods and services, which drives prices down, further trimming businesses’ revenue and thus their ability to pay employees, who in consequence spend less. The cycle continues, until incomes fall so low that there’s no longer cash available to reduce the debt. And as incomes and business profits decline, so do government tax receipts, resulting in fewer police officers, more unfilled potholes, and greater pressure on pensioners.

A deleveraging nation, economists say, risks higher unemployment and years of subpar economic growth and could trigger a deflationary spiral in which consumers forgo spending, anticipating lower prices in the future. “When economies are deleveraging,” Atlanta Federal Reserve Bank President Dennis Lockhart said in a recent speech, “they cannot grow as rapidly as they might otherwise.”

Economists offer two (or more) contradictory answers. Keynesians believe that government can break the downward spiral by borrowing money and injecting it into the economy, replacing the income lost when jobs disappear and consumers don’t spend as before. The government-driven uptick in demand, the thinking goes, instills confidence that economic activity will pick up, spurring hiring and giving consumers the means to spend while paying down their debt. Once the economy starts to grow faster than the government’s borrowing, the debt will decline as a percentage of economic output.

Let’s hope, then, that the conservative economists are right about a deleveraged nation and its ultimate rewards. They see government spending as only a short-run “sugar high” that extracts two intolerably high costs in return. One is that investors, worried about the government’s ability to repay the additional debt, will drive up interest rates. The other: Business owners, spooked by the higher taxes to come, will pull in their horns. “There’s tremendous uncertainty about what government is going to do to meet its liabilities,” George Mason University economist Richard Wagner said. “So businesses hesitate to invest.”

But in the long run, these economists say, the short-run pain will give way to long-term gain. If the government stops soaking up most of the available credit, “that frees up money that business can use to hire and invest,” Wagner said. Similarly, he said, if working people know that future Medicare and Social Security payments will decline, they’ll have more incentive to work hard and save for the future.

via The Recovery’s Silent Assassin: How Debt Deleveraging Killed the Economy – Harris Collingwood – Business – The Atlantic.

Interesting points! When everyone is moving to the same direction, it’s like an army of soldiers step on the same bridge – the synergy can break the bridge.

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