Household debt: Free the interest rates

Malaysia’s household debt to gross domestic product (GDP) ratio, which stands at 86.8% in 2013, is one of the highest in the Asia Pacific region.

Like many economists and commentators, I fear that it will get worse. The household debt too, appears to me as a clearly unsustainable economic trend in the long run.

However, this rise in household debt has led to a very weak warning from the government and Bank Negara and the reluctance to admit the current level of household debt holds the most significant risk to the economy.

More government regulations to scale back the household debt level are ineffective, because regulation has its limits.

They ignore the fact that artificial low interest rates is the problem.

Of course in the economic report, the arrears rates are minimal while rising inflation is eating into their disposable income, leaving them with less and lesser to spend and save each month, suggesting an increasing burden on Malaysian households.

Let’s continue.

First, in today’s economy, an artificial low interest rate determined by Bank Negara is the real cause of the household debts.

Interest rate is a price which represents the time value of money.

The price of obtaining a loan is set by the rate of interest. The higher the rate of interest for any period of time, the higher the price of the loan.

As the rate of interest falls, more debt is demanded while other things remain equal.

The same principle applies to price control, where free market economists agree that price control don’t accomplish what they intend to do and by keeping prices artificially low, demand is increased to the point where supply cannot keep up, leading to shortages in the price controlled product.

This is essentially the Austrian economic theory which Bank Negara should pay attention to.

I just don’t understand why many policymakers and economists recognize the problem with price controls on physical goods, but not with the money that represents those goods.

I was wondering what money is, what interest rate is to them.

Do they know that artificially low interest rates continue to cause malinvestment and misallocation of resources throughout the economy?

Do they know that savers and retirees suffer from artificial low interest rates?

I always said that there is no way for Bank Negara to know what interest rates should be.

I don’t know. So let the market decide.

Second, the combination of low interest rates and easy access to credit in recent years has encouraged many households in Malaysia to borrow against their future income to finance their present consumption.

Statistics show the bulk of Malaysia’s household debt is made of home mortgage loans as households take advantage of the prevailing low interest rates to buy properties, leading to increased demand and eventually the significant increase in property prices in the country in recent years.

To understand why housing is such a driver of debt burden, we need to look at the role of government spending in housing and related sectors over the years.

Back to the principle, when the price of leasing money fell, more Malaysians borrowed the money and used it to buy housing and cars. And more income diverted towards debt repayment.

If they don’t pay debts, they will become part of bankruptcy statistics.

Other economists are saying this easy consumer spending has contributed to the country’s economic growth.

Strong domestic economic spending to drive growth. Very Keynesian economic argument, and I don’t buy that.

Certainly the demand for goods and services rises are increasingly funded via credit and not constrained solely to income growth.

Then, the industries adapt to this higher level of demand resulting in artificially strong economic expansion accompanied by artificially low unemployment.

Malaysian households are merely responding to the artificial low interest rates. That’s all.

The government and Bank Negara should not think Malaysians are acting irrationally. Each man knows how importance saving and bad debt is.

They do make monthly budgets, they adjust to the economy. It is just the artificial low interest rates that signaled them to do self-destructive things like household debts.

So with the free interest rates, they would be even more financial pain.

It would be a necessary economic correction, painful cure and more important, our households would save again.

Published by The Malaysian Insider on 14 June 2014.

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