I think it’s fair to say that a majority of economists believe that excessive private debt played a key role in getting us into this economic mess, and is playing a key role in preventing us from getting out. So, how does it end?
A naive view says that what we need is a return to virtue: everyone needs to save more, pay down debt, and restore healthy balance sheets.
The problem with this view is the fallacy of composition: when everyone tries to pay down debt at the same time, the result is a depressed economy and falling inflation, which cause the ratio of debt to income to rise if anything. That is, we’re living in a world in which the twin paradoxes of thrift and deleveraging hold, and hence in which individual virtue ends up being collective vice.
So what will happen? In the end, I’d argue, what must happen is an effective default on a significant part of debt, one way or another. The default could be implicit, via a period of moderate inflation that reduces the real burden of debt; that’s how World War II cured the depression. Or, if not, we could see a gradual, painful process of individual defaults and bankruptcies, which ends up reducing overall debt.
And that’s what is happening now: as this story in today’s Times points out, the main force behind the gratifying decline in consumer debt appears to be default rather than thrift.
So basically, we can do this cleanly or we can do this ugly. And ugly is the way we’re going.More Here..