Consumer credit card debt in America is at a record high of $1.14 trillion and still growing. Whether caught up in this debt or not, it’s hard not to worry about the future. Many wonder if all this debt poses a systemic risk to our country’s economy.
If you are worried about what will happen next, let’s examine the experts’ predictions about whether we are facing a credit card debt time bomb and, if so, when it’s likely to go off.
Key Takeaways
- U.S. credit card debt has reached a record high of 1.14 trillion.
- A debt bomb occurs when a country or large sector accumulates so much debt that it cannot pay it off. When a debt bomb explodes, it poses a risk to the broader economy.
- Managing a debt bomb requires early detection and policy reforms.
What Is a Debt Bomb?
A debt bomb occurs when a country or a significant financial institution accumulates a lot of debt and defaults on it. The explosion affects the rest of the economy.
But how does a debt bomb happen? What causes a financial institution or a country to accumulate so much debt without a way to fix its financial problems? Here are the most common reasons:
- Borrowing too much
- Going into a recession
- Suffering an economic downturn
Total U.S. Household Credit Card Debt
As mentioned, American families owe more than $1 trillion through credit cards alone, which is about $6,000 for each family. This is a lot compared to previous years, and it marks a 10.77% increase from the same period.
Examples of Debt Bombs
In 2009, the European Sovereign Debt Crisis took place in several European countries, including Ireland, Portugal, Spain, and Italy. The country most affected by this crisis was Greece, which revealed that it needed bailout packages from the European Union and the International Monetary Fund of over €300 billion.
Major protests, strikes, and political changes took place within the country. But that’s not all; the country’s GDP declined by over 25% while unemployment rates rose above 27%. This lasted for eight years. It also affected the global financial market as global economies are interconnected.
Another historical debt bomb exploded in Latin America in the 1980s. Countries like Mexico, Brazil, and Argentina had borrowed money to finance development projects and could not repay it.
At the same time, the world was going through a recession, which led to decreased demand for Latin American exports. But that’s not all. The U.S. Federal Reserve also increased its interest rates, making it even harder for these countries to pay off their debts.
As a result, poverty and unemployment rates across the region increased, leading international institutions like the International Monetary Fund and the World Bank to change their lending practices.
What Happens If a Debt Bomb Explodes?
When a country or financial institution cannot pay back its debts anymore, this raises a red flag for creditors. As a result, creditors will further restrict them from accessing funds in the future and can even pursue legal remedies. Even if the financial institution or country can borrow, it will be asked to pay extremely high interest because creditors view it as high risk.
So, when the country lacks money, the government cannot operate normally. Financial institutions will also stop lending to businesses and consumers as they don’t have enough funds, resulting in additional losses that threaten their solvency.
It gets worse. After the country defaults and the bomb explodes, its currency may depreciate sharply. So, paying back the loan becomes even more difficult when the local currency becomes weak and the debt is borrowed in another currency.
Not only that, but importing from outside also becomes expensive. What does this lead to? Inflation and economic recession. This may even cause the world’s richest people to take a financial hit.
A debt bomb exploding can also result in declining public services like healthcare, education, and infrastructure, as the government doesn’t have the revenue to fund these. And what happens when people don’t have access to healthcare and education? Protests, strikes, political instability, and emigration follow.
Managing a Debt Bomb
The most effective way to manage a debt bomb is to detect it early. This involves monitoring debt levels relative to GDP and revenue. Then, governments should implement fiscal adjustments and policy reforms. This includes cutting down unnecessary expenses and ensuring a fair taxation system is in place.
If the country’s debt levels are too high and unsustainable, it should seek help from domestic or international creditors. This helps find a mutually beneficial solution, such as adjusting repayment schedules or cutting interest rates. Both parties can negotiate a “haircut,” which reduces the principal amount to improve the chances of paying off the debt.
Most importantly, there are two organizations that countries can turn to when facing a debt bomb: the IMF and the World Bank. The IMF requires specific economic reforms to stabilize the economy, while the World Bank funds development projects.
The government must recapitalize the banks by encouraging investment to stabilize the banking sector. One way to promote investments to help the economy grow is by offering tax breaks and simplifying business registration processes. Banks should also put in place regulatory frameworks to prevent risky lending so they have enough capital to buffer.
For example, in the 1990s, Canada faced a debt bomb due to its high debt-to-GDP ratio. However, it emerged successfully. The country cut unnecessary expenses, reformed its tax system, and continued to invest in critical areas like education and healthcare.
In 2008, Iceland’s banking sector collapsed. However, it recovered successfully by letting failing banks go bankrupt and seeking help from the IMF.
When a debt bomb explodes in one country, its aftermath can be felt worldwide. It creates a chain reaction that affects markets, investor confidence, and growth worldwide. To avoid this, governments and institutions should prioritize sustainable borrowing practices. This way, we ensure stability and prosperity for the generations to come.