The Effects of Debt

Updated on January 9, 2019
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Marcus received his bachelors of science in 2017. It is a business degree with an emphasis in technology.

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Introduction

With the holidays winding down, people are looking to pay off the massive credit card balances they have accrued throughout the holiday season. Household debt has reached a record high of $13.51 trillion as of last quarter, $9.1 trillion of which is mortgage debt. This has exceeded levels not seen since 2008. The U.S Federal debt is approximately $21.8 trillion and rising. Global debt has reached a high of $247 trillion and rising. The effects of high levels of both public and private debt will result in lower GDP growth in the long term as well as even psychological issues as total private debt increases. Public and private debt has even been shown to influence each other as they both increase and decrease.

Psycological Effects of Debt

A study at the University of Southampton has shown that people in debt are three times more likely to have mental issues. Less than 9% of the participants surveyed had debt while not having mental issues, compared to over 25% of the participants having both mental issues and debt. Another study demonstrated that even thinking about financial insecurity increased pain, people have even admitted that they feel twice the pain recalling financially difficult times vs financially stable times. Moreover, individuals in debt were more likely to suffer from depression, develop psychosis and are even more likely to develop a dependence on drugs; people with debt are more likely to commit suicide than individuals without debt.

All in all, addressing only mental health or debt alone is ineffective, furthermore, if both are addressed but without coordination, the situation still worsens. The only way to help people with mental health issues get out of debt is to coordinate building up their financial health and their mental health.

Effects of Household Debt on the Economy

Since the end of the Great Recession, global household debt to GDP has increased dramatically with Switzerland leading the charge at 128.8%, followed by Australia at 121.3% household debt to GDP. The US is ranked at #11 with 77.3% household debt to GDP. According to Mehmet Caner’s Partners in Debt, household debt boosts GDP for only one year, moreover, for every 1% increase of household debt to GDP, it results in a 0.1% decrease in GDP growth in the long run. Once private debt (household debt) to GDP moves pass 60%, consumption decreases dramatically; at 80% private debt to GDP, the negative effect that private debt has on growth increases dramatically. However, lowering debt levels may not increase growth if wages are stagnant.

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Effects of Government Debt

The increase of government debt also has adverse long-term effects on the economy as borrowing increases. Once public debt to GDP reaches the tipping point, over 77%, it will result in long-term GDP decline; this number varies for each country, for China and Guatemala, the tipping point is 64%. Once public debt to GDP reaches the 90% mark, any increase of government debt will have a negative impact on GDP growth. This is because as government debt increases, interest payments for the debt increases, which leads to less public investment in infrastructure, education, healthcare, etc. In the United States, interest payments for the federal debt will become the 3rd largest expenditure for the US government by 2048, resulting in less money for defense and infrastructure and higher taxes.

Government debt also has an adverse effect on corporate debt as well. Increases in government debt encourages companies to hold onto cash and other liquid assets due to increased borrowing costs resulting in the supply of safer debt instruments, as a result, companies will have to pay a higher interest rate to attract investors. They are also less likely to invest because borrowing costs driven up by government bonds. According to Wharton Business School, increases in government debt will decrease corporate debt by a third, in the long run; however, this is not the case now, because of low interest rates. Finally, lenders are also affected by the ebb and flow of government debt as well; for every one percent bank, pension funds, and insurance companies loan the government, corporate lending by these groups drops by 4-12 basis points, resulting in less economic growth and fewer jobs.

Debt Interaction Equation

Public Private Debt Interaction

Now that we have gone over the effects of both public debt and private debt on their own, we will now go over the effects the interaction of public debt with private debt. We can see the interaction of public and private debt when the government guarantees debt, which converts the private debt to public debt; mortgages and student loans are some examples of debt guaranteed by the government. Debt interaction reaches dangerous levels when they exceed levels of 137%; according to Ohio State University’s Mehmet Caner, twelve out of the 29 countries, he studied are either at this critical juncture or have exceeded it. The U.S debt interaction stands at 203% during the period of 2009-2014, other offenders include the following: Japan at 543.07%, Ireland at 406.7%, Portugal at 364.61%, Italy at 226.11% and Spain at 203.8% debt interaction.

High levels of debt interaction have reduced GDP growth for the U.S by 0.43%, total debt, both public and private, reduced U.S GDP growth by .83% from 2009-2014. Decreases in public debt can reduce any increases of private debt and vice versa and increases to both will harm growth in the long run.

Debt Interaction

Country
Public Private Debt Interaction
United States
203%
Ireland
406.7%
Spain
203.8%
Japan
503.47

Conclusion

All in all, the increase in global debt is beginning to put the global economy on a dangerous precipice. The U.S alone has $21 trillion in public debt and $13.51 trillion in private debt and there is $247 trillion in global debt, which is 318% of global GDP. The effects of high debt for consumers includes mental illnesses, such as depression and anxiety, and long-term reduction in GDP, resulting in fewer jobs and less wage growth. The effects of increasing public debt will result in higher taxes and less services for the populace, as debt payments become a larger part of the budget. Even the interaction of public and private debt has negative implications on growth as well.

Bibliography

Caner, Mehmet, et al. “Partners in Debt: An Endogenous Nonlinear Analysis of Interaction of Public and Private Debt on Growth.” SSRN Electronic Journal, 27 May 2018, doi:10.2139/ssrn.3186077.

“The Emotional Effects of Debt - Denial, Stress, Fear, Depression.” Debt.org, Debt.org, 2019, www.debt.org/advice/emotional-effects/.

“The Fiscal & Economic Impact of the National Debt.” Peter G. Peterson Foundation, Peter G. Peterson Foundation, 2019, www.pgpf.org/the-fiscal-and-economic-challenge/fiscal-and-economic-impact.

Grabmeier, Jeff. “How the United States Landed in a Debt 'Danger Zone'.” Phys.org - News and Articles on Science and Technology, Phys.org, 21 Aug. 2018, phys.org/news/2018-08-states-debt-danger-zone.html.

“Household Debt Hit a Record High of $13.5 Trillion Last Quarter.” NBCNews.com, NBCUniversal News Group, 26 Nov. 2018, www.nbcnews.com/business/consumer/household-debt-hit-record-high-13-5-trillion-last-quarter-n937216.

Jenkins, Rachel, et al. Recession, Debt and Mental Health: Challenges and Solutions. US National Library of Medicine: National Institutes of Health, 2009, www.ncbi.nlm.nih.gov/pmc/articles/PMC2777607/.Research.

“Government Debt Issues Can Raise Corporate Bond Costs.” Knowledge@Wharton, Wharton School of the University of Pennsylvania, 25 Mar. 2015, knowledge.wharton.upenn.edu/article/the-important-role-of-government-debt-in-shaping-corporate-behavior/.

“Study Finds National Debt 'Tipping Point' That Slows Economic Growth.” Phys.org - News and Articles on Science and Technology, Phys.org, 28 Sept. 2010, phys.org/news/2010-09-national-debt-economic-growth.html#nRlv.

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    © 2019 Marcus T Caine

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