Economists say debt greases the wheels of commerce. It allows consumers and businesses to make big investments today by promising some of their future earnings. The economy wouldn't work well without it. However, when unexpected events cause incomes to shrink (or disappear), debts must be repaid anyway. After the Global Financial Crisis of 2008, many people took advantage of extremely low interest rates to borrow money cheaply. Now that interest rates have risen, the burden of that debt is beginning to hurt. A painful correction is happening in the economy.
Living with rising costs
Covid-19 and Russia's war in Ukraine have delivered heavy blows to the world economy. Many governments focused on protecting household incomes, by stimulating their economies and subsidizing energy costs — pumping money into the system. This might be one reason for high inflation, but may also have led consumers to underestimate the risk of large debts. As Forbes reports: "The pandemic did not put a stop to Americans' borrowing, even amid faster income growth [from government financial assistance]." In September 2022, total US consumer debt was estimated to be $16.5 trillion. The average American household had $96,371 of debt, composed mainly of mortgages, car loans, student loans and home equity lines of credit (HELOC), which are loans secured by the value of your home.
A study by the New York Federal Reserve found that "Americans are borrowing more, but a big part of the increased borrowing is attributable to higher prices." This means people are going deeper into debt to cover the higher cost of living. Americans got 18.6 million new credit cards in the first quarter of 2022, and $46 billion was added to credit card balances in the next quarter. With the cost of food rising 13.5 per cent in just 12 months, housing costs increasing by 6.2 per cent and medical care up by 5.6 per cent, US credit card debt is rising faster than at any time in the past 20 years.
The burden of an education
Another significant source of debt for Americans is student loans. Overall, federal student-loan debt has increased significantly since 2007. Nearly 45 million Americans share $1.75 trillion of debt for their college education. A survey by bestcolleges.com found that 44 per cent of undergraduate students with federal or private loans have thought about quitting college because of the cost. Ashlee, 27, dropped out of university but still has to repay $12,000. "I'm drowning in debt for a piece of paper I never received," she told NPR. "Nobody should be in that position."
During the pandemic, the federal government paused student loan interest and repayments. In October 2022, President Biden started a student loan relief programme to cancel up to $10,000 of debt for those who earn under $125,000 a year. For some, that won't be enough if the cost of living continues to rise.
Your money or your life?
An emergency operation comes with the tremendous stress of having your own life, or that of a loved one, in danger. For many people, in the US in particular, there's the added stress of having to pay the bill for medical treatment.
Jeni Rae Peters, from Rapid City, South Dakota, was diagnosed with breast cancer two years ago. Her treatment was successful, but she now owes more than $30,000. "My doctor saved my life, but my medical bills are stealing from my children's lives," Peters told NPR.
This situation is not unusual. Critics have long argued that America's healthcare system pushes patients into debt. According to the Kaiser Family Foundation, over half of US adults say they have been in debt because of medical or dental bills in the past five years. Medical debt now affects 100 million Americans, much more than was previously thought.
The unforgiving system can also leave patients with a huge emotional burden, particularly when the debt is associated with a traumatic event. For example, 31-year-old medical student Edy Adams got numerous calls from debt collectors about payment for a medical exam she was given after being sexually assaulted. "I was being haunted by this zombie bill," she told NPR. "I couldn't make it stop."
Increasing debt just to pay the bills
The Guardian reported, in late 2022, that 2.3 million UK households were behind on their electricity bills (and 1.9 million on their gas bills) even before the winter began — and that both figures have increased by nearly two-thirds since the end of 2020.
Bakery owner Sophia Sutton-Jones, who runs Sourdough Sophia in London, has seen her monthly electricity bill shoot up from £1,500 to £5,500 (€6,340). "Where should I magically take £4,000 per month extra that I didn't calculate for?" she told AP News. And James Allcocks, owner of the Pig & Whistle Bistro in Beverley, in north-eastern England, has seen his annual electricity costs jump by more than 650 per cent. He told Sky News: "I will fight to the end, but I do feel like the band on the Titanic or that I'm re-arranging the deck chairs to stop it sinking."
The government has reacted with measures to limit the damage caused by sharply rising energy costs, but debt charities, such as Citizens Advice, warn that the cost of living crisis threatens to get worse — saying that some people are turning off fridges and washing clothes by hand just to reduce their energy bills.
In August 2022, credit card spending across the UK reached £700 million. The sharp rise in people borrowing money to cover essential costs, such as gas and electricity, is a clear sign that a crisis is brewing and that urgent action is needed. "If people need short-term and emergency loans just to get by … that needs to be managed very carefully," says Samuel Davies, from the online loan-matching service Kallyss.
After 40 years, fear of inflation has returned, and central banks are raising interest rates to bring inflation back down. The question is: How much pain will that cause? In countries where households and businesses have excessive debts, it will not take long to find out.
What’s happening in Germany?
Debt is growing in Germany, too, where average private debt is €31,087 (in 2022). Many people have financial worries.
- Around 600,000 people a year ask for debtor or insolvency advice because of private debt.
- In 2021, around 13 million people in Germany were at risk of poverty, about 16 per cent of the population.
- Over a quarter of pensioners have a net monthly income of less than €1,000.
- According to a study by the Friedrich Ebert Stiftung, 29.5 per cent of Germans say their financial situation has got worse since the pandemic began.