The Debt-Fueled Economy

by Gary on March 1, 2013

Consumption is rising, which is good for this economy.  Many retailers are reporting increased sales, big ticket purchases (like cars) are at the highest they have been in a decade, and banks have reported more requests for credit. Americans are spending again.

The latest Federal Reserve consumer credit data release shows that, while Americans are taking more auto and student loans, they are being shy with credit card spending. The data shows that overall borrowing rose in December for a fifth straight month. In fact, non-revolving debt, such as car loans and student loans, rose by $18.2 billion in December—the largest increase since 2001. While serious credit card delinquencies have risen in the last year, credit card borrowing was down $3.6 billion in December.

Controlled Spending

Some consider the fallen credit card debt to be a sign that consumers are managing their credit well. Paying off one’s debt and building up savings is good for the individual. The question is, in this consumer-driven economy, should Americans be willing to take on more debt from spending?

It might be better for the economy, but we are at a peculiar time in our economy’s history. There is no doubt that the economic disaster that hit several years ago still lingers in the average American’s mind. Many Americans are still unemployed or underemployed, and those who have secured sufficient employment may not feel it is that secure. Add in the expiration of the payroll tax holiday, so workers are taking home a smaller share of their earnings, and it is only natural for Americans to be wary about looser spending.

Learning from the Past

Prior to the recession, consumption was rampant. Banks were handing out subprime loans left and right, Americans were borrowing against their unaffordable homes, and consumers were piling credit card debt up to their necks. Many people were simply living a lifestyle they could not sustain.

Then the recession hit, leaving consumers and business no choice but to reduce their debts. At its worst in 2007, consumers were using about $14.08 of every $100 to repay loans. Five years later, that amount shrunk to just $10.61. Americans got rid of a lot of debt, but that means they were spending less disposable income on consumption.

Financial Optimism

It is great that Americans are better handling their finances, keeping their debt under control. There is no doubt that the Great Recession has made a lasting change in the minds and habits of consumers. And while healthy spending is necessary for our economy, financial responsibility and stability should be a top priority for American households.

We are starting to see some renewed optimism and confidence among consumers and economists. We are looking at rising home prices in many areas of the nation, a relatively strong U.S. jobs report, a bull market for stocks, and cheaper financing for many big-ticket items. This is all good news for a lot of people and may be boosting a bit of consumer confidence. With more confidence and financial security, consumers may be priming the market for increased consumer spending, and in turn, building a stronger economy.

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