The Great Deleveraging and the Reason why the Global Economic Recovery would Falter

The Effect of Two Decades of Profligate Spending

Everyone expects the global economy to recover in a magical way and for the good times to return. We are constantly fed on a steady barrage of feel good messages from the marketers about the goods and services they make and sell with the intention of making us consume their products.

Similarly, many experts write articles, appear on television debates extolling us to believe in capitalism and free markets and spend and shop with the idea that such consumption would kick start growth, and return us to the recovery that everyone predicts is right around the corner. The only problem with all this optimistic talk is that the public, the private sectors, and the households in most parts of the world are drowning in debt.

Thanks to the booming nineties and the irrational exuberance of the first decade of this century, most companies, governments, and individuals have excess debt that they have accumulated during these two decades. Therefore, the clear consequences of such debt are that it has to repaid someday and the day of reckoning arrived with the onset of the global economic crisis of 2008.

Why Consumption is Falling and Savings are Increasing

Suppose you are an individual who is working in a steady job and has bought a house, a car, and other items as well as financed the education of your kids by borrowing from the bank or the financial institutions.

Assuming you have lived within your means and desisted from excess consumption, the chances are that your EMI’s (Equated Monthly Installments) for the loans that you have taken take up half of your salary and your spouse’s as well. This situation does not go out of hand as long as you are getting pay hikes and good bonuses, which would ensure that you could pay your EMIs, and yet have something to save and spend.

With the arrival of the global economic crisis, many companies have not been giving pay hikes and bonuses. In this situation, your first priority would be to pay off the loans and manage your expenses within your budget.

If you factor in inflation, then you must also have to provision for the excess expenditure because of rising costs of goods and services.

The clear implication of this is that you are not in a position to spend as much as you did during the boom years. The net result is that you learn to spend less, save more, and keep aside more money for the loans.

What is Deleveraging and the consequences of the same ?

If we take the situation described above, it becomes clear that the term deleveraging or paying off the debt and winding down consumption is the first priority for individuals, the private sector, and the government.

Taking only the individuals (we shall discuss the other two sectors separately), we find that the kind of consumption that is needed for the economy to recover is not taking place and despite all the exhortations of marketers and experts, individuals are consuming less and saving more because they are worried about the future. This begs the question as to where shall the growth come from if consumption goes down in the economy.

This is the key aspect why the global economy is not recovering as consumers are deleveraging which means that they are not that gung ho about spending like they did in the last two decades. This is also the reason why consumer confidence is at all time lows as individuals and households deleverage.

Of course, you can always take another loan or loans to sustain their consumption. However, as commonsense would tell you, taking more debt to repay the existing debt would lead you nowhere and indeed, can make you bankrupt when the eventual day of reckoning arrives.

Since the global economy already had a day of reckoning in 2008, many individuals are deeply concerned about the recurrence of another crisis. In conclusion, because of this deleveraging, the global economic recovery is going to falter.