Continued declines in consumer debt

The Federal Reserve reported yesterday that in July for the sixth consecutive month consumer debt declined. Specifically, debt, sans real estate loans, declined 10.4%. This large drop was a record. Clearly consumers are taking out fewer loans for automobiles, and using credit cards less and less.

The spin from most analysts and economists is that these numbers bode ill for the economic recovery. This is because consumer spending is typically about 70% of Gross Domestic Product. I have to tell you though that the U.S. economy is undergoing a sea change. The primary change is that debt of all flavors is being shed by people and businesses alike. In the long run I consider this to be a very positive change for the economy. Why?

In my opinion debt is appropriate to finance only those purchases where saving long-term for something would diminish its usage. Huh? The classic example is a house. If we all had to save for a house over the course of 30 years we would not get to experience the benefits of the asset until many, many years after our initial interest in the asset. I can only think of 2 other assets that fit this criteria: automobiles and education. Automobiles dramatically increase the ability of people to effectively manage their time and thus warrant taking on debt to purchase. The advantages of higher education are all too obvious.

By my way of thinking, beyond the utilitarian transportation benefits of a car, everything else is wasteful spending. So that Mercedes provides no excess transportation utility beyond a Ford Focus. All of what makes a Mercedes more expensive is a misuse of debt in my opinion. You see, it’s all about rates of return. If we pay an interest rate of 5-8% on our car then we compare that paid interest rate to the received/perceived rate of return (i.e. utility) of the various aspects of our car. Clearly the pure transportation aspect of a car is its most valuable feature. What value does the Mercedes have if it won’t move? But what is the real utility of power windows? Or of heated seats? Yes, yes, I love those features, too. But can we honestly say that the benefit, the rate of return, on these features is in excess of the interest rate of 5-8% we pay?

For a house, a car and an education the benefits are fairly obvious, and typically in excess of the interest rate paid on the loans. But what is the rate of return on an investment in an unneeded blouse or pair of shoes when that purchase is financed on a credit card charging an 18% interest rate? Clearly we are no longer in the “black ink” on investments like this. This is personal finance “red ink.”

Most importantly, what is the long-term effect of an entire nation that makes investment decisions so ignorantly? I think it is fairly obvious that credit card debt is a tax on the economy that only enriches the owners of credit card issuers. Long-term, say over the course of 50 years or so, an economy’s growth cannot sustain so many negative return investments without collapsing. After all, what sustains the ability of a nation’s people to be able to make these kinds of horrible kinds of investments is excess returns on other investments. How is that? Somewhere someone has to be making money on their investments to be able to lend money to the credit-card purchasing folks. But if the use of expensive credit is used to make so many black hole investments, eventually it overwhelms the positive investments made by others. After all, it’s very easy to make poor investment choices and not so easy to make investments with positive and high returns, yes?

Where does the financing come from in the long-term when poor investments overwhelm positive investments? In the long-term it comes from people outside of the bankrupting economy: foreigners. What happens when we are financed (and ultimately owned) by a nation without our same national interest? A tremendous loss of sovereignty and power.

This is the context by which I am evaluating consumer debt levels. In the short-run the numbers are distressing. Buy this is true only if we continue to feel that the economy is healthiest when 70% of it is financed at around 18%. This is crazy thinking. What about an economy of savers that saves for its purchases? When consumers save money they earn interest on the savings and then when they purchase an additional blouse the return on investment comparison of rates of return is entirely positive. But what kind of investment does this state require?

It requires that consumers bridge the time gap between being debtors to becoming creditors. This takes time as consumers pay off credit cards and then begin saving for purchases. The amount of time necessary is contingent on just how high the amount of credit for each consumer is. So when we hear that consumer debt levels are down for the sixth consecutive month and that the two most recent declines are down 7.4% and then 10.4% are we to be alarmed? In my mind, no. What this means is that Americans are getting “it.” It also means that many are making hard choices and doing the right thing for the first time in 30 years. How can this be a bad thing?

Jason