Global debt hit $233 trillion in the last quarter of 2017. That is higher than it has ever been. Households owe around $44 trillion of this debt, which is considerably higher than the $15 trillion owed in 1997. How much of this figure is credit card debt and what impact does this have on economic growth?
An Experian Credit report in 2017 reported that US consumers have, on average, two credit cards with a combined balance of $5,551. This equates to 30% of their total credit limit. Given that most credit cards charge interest somewhere between 15% and 20%, paying the minimum each month leads to increased debt.
Rising Credit Card Debt
In the UK, growth in credit card debt is now the highest it has been for 12 years. Credit card debt is around £70 billion, or 35% of the UK’s personal debt total. What’s worrying is that credit card debt is now greater than it was prior to the last recession.
Much of this indebtedness has been fuelled by historically low interest rates. A former member of the Monetary Policy Committee warned last year that low interest rates were fuelling consumer debt binges. He criticised the Bank of England for not raising interest rates, despite inflation being higher than the bank’s target rate of 2%. The Bank of England has since raised interest rates from 0.5% to 0.75%, which was where interest rates were when the last recession hit. Nevertheless, interest rates are still low enough to encourage proliferate spending.
Is Debt a Problem?
Consumers see debt as an issue, but debt in and of itself is not necessarily a problem. Borrowing money to increase productivity is a good thing. With access to money, businesses would not be able to start or grow, which would have a negative impact on global economies. Debt is not inherently bad, but excessive debt is.
Consumers use credit cards from to buy things; spending fuels the economy, which in turns leads to an increased GDP. An economy can’t grow unless the people are spending their money on products and services. Unfortunately, the benefits of debt-fuelled growth are not long-term.
Research by the IMF has found that although credit card spending – along with consumer spending in other areas – does prop up economic growth, it also increases the risk of economic collapse. In the short-term (typically 3-5 years), an increase in the debt/GDP ratio is linked to low unemployment and higher economic growth, but after 3-5 years, these positive effects slip into reverse. High levels of debt expose households to income shocks and in the long-term, high indebtedness forces consumers to reign in their spending, which in turn has a negative impact on the economy.
Rampant Indebtedness Causing Concern
The Bank of England is concerned about the increasing level of indebtedness in the UK. Analysis by the FCA and BoE found that 89% of consumers with credit card debt were also in debt two years previously. This suggests that many consumers are trapped by their debt for longer than previously thought. Indeed, many shift their debt from one lender to another without paying off the underlying debt.
As we all know, reckless lending was one of the primary causes of the last global recession. When debt is high and cannot be serviced, the lender loses money. Back in 2008, people were lured into buying properties they couldn’t afford. An escalating foreclosure rate caused a loss of confidence in the financial markets, which triggered a massive credit crunch.
Economic conditions today are not the same and most banks are in a better position, but experts are still concerned about rising consumer debt and its effect on global economies. If interest rates rise much further, households will default on their debt repayments, which could trigger another economic disaster.
Mitigating the Risks
Governments can mitigate the risks of high credit card spending. The Bank of England has forced banks to increase their reserves, so they are in a stronger financial position. In addition, better regulation, flexible exchange rates, and a reduced dependence on external financing can all reduce the impact of rising indebtedness on economic growth.
Whether these policies will help us to avoid another catastrophic economic recession remains to be seen.