With the advent of 2020, developed world economies are trying to keep their balance on the volatile basis of strong consumption, high asset prices and high household debt. Any major shock or increase in volatility can cause “vicious circles” that would compromise the economic and financial system.

The latest financial crisis ended more than a decade ago. In recent years, personal consumption, fueled by scarce government spending, has supported growth. Increasing employment has helped people buy more. But with low wage growth, borrowing secured through high-value housing and equities was a major factor in consumption. The policies of central banks and governments, which have led to high asset prices and collateral values, have allowed for additional loans.

In theory, the effect of wealth increases consumption. But higher asset prices may not translate into cash flow and households may owe even more debt. Consider using тхе low interest rates for housing investment, borrowing from your own home, and outsourcing property and financial assets to build wealth.

Global household debt reached about 75% of gross domestic product, with particularly high levels in some developed economies. The figure was around 57% in 2007 and 42% in 1997. Even at very low interest rates, household debt-to-income ratios remain high, ranging from 8% to 16%.

This combination of high consumption, prices and debt is unsustainable and can lead to a self-affirming enchantment. Initially, asset price increases favor credit and consumption expansion, leading to further price increases. However, slower growth, unemployment, declining incomes and asset values ​​can quickly reverse this cycle.

Negative shocks are transmitted through the household finance structure. From a balance point of view, assets such as homes and financial investments are financed by mortgages or other debt. From a cash flow perspective, employment and investment income must cover consumption and debt repayment.

Any shock to income – unemployment, lower profits, falling interest or dividend income – must be offset by reduced consumption. Higher debt payments or the inability to refinance put pressure on consumption capacity. Declining house prices and declining values ​​of financial investments weaken the household balance, causing reduced consumption or accelerated debt reduction.

These first-line effects are propagated through successive disturbances that quickly heighten stress.

One of the areas of contagion is the financial sector. The large negative shocks underscore the risk of excessive risk-taking by borrowers and lenders. If labor market conditions deteriorate, vulnerable households will not be able to pay their debts. Non-performing loans are increasing. Banks, for their part, are tightening lending, making it less accessible and more expensive. Maturing debt becomes difficult to refinance, which exacerbates the pressure on cash flow.

Forced sales, bankruptcies, and seizures of goods whose payment is overdue give rise to a spiral of falling prices among the various asset classes. The shrinking net wealth of households and the decline in the value of a collateral lead to even less consumption. Deferred home purchases affect construction. This has a significant impact on the US and the Eurozone, where the housing sector represents about one-sixth of the economy.

Where banks are a major part of the stock market, such as in the US, UK and Australia, the contagion is further transmitted through the reduced profit of financial institutions, which pushes stock prices and dividends. The loss of net worth and income additionally hits the consumption of investors who rely on this cash flow.

Public finances are also affected. Total tax collection is falling. Direct revenue from property and financial transactions declines. If the government is to support financial institutions – the traditional consequence of a collapse in asset prices – the funds needed to recapitalize banks and secure deposits are burdening government balances, which are already weaker after 2008. Since the withdrawal of foreign investors, it shrinks the current account and undermines the value of the currency.

The cycle continues in successive phases until a new balance is reached. Australia has just been through this process. The shock caused by tightening credit conditions has led to a decline in home prices, which has slowed growth and weakened the financial sector. Reducing interest rates by 0.75 percentage points, weakening credit controls and government measures have brought temporary stability.

Recent actions by central banks around the world – a tendency to weaken monetary policy and resume quantitative easing – reflect the awareness that policies should support asset prices in order to protect consumption, which represents about 50% to 60% of developed GDP economy. The problem is that these policies consolidate and increase debt, prevent normal asset price cycles, and increase household vulnerability.

The ability to maintain this unstable equilibrium remains the key to the prospects of developed economies. The social tension under which this equilibrium is placed, in terms of purchasing power and affordability of housing, is increasingly expressed in mass protests around the world.