Consumer Credit and the American Conundrum

Courtesy of Doug Short.

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What to do? This is not as an innocuous question as one might think. Why? Because most American families, who have to balance their living standards to their income, face this conundrum each and every month. Today, more than ever, the walk to the end of the driveway has become a dreaded thing as bills loom large in the dark abyss of the mailbox. What to do?

The conundrum exists because there is not enough money to cover the costs of the current living standard. The average family of four has few choices available. The burden of debt that was accumulated during the credit boom can’t simply be disposed of. Many can’t sell their house because 1 in 4 homes is worth less than what they owe. There is no ability to substantially increase disposable incomes because of a weak employment environment and deflationary wage pressures. Despite the mainstream spin on recent statistical economic improvements, the burdens on the average American family are increasing. Nothing brought this to light more than yesterday’s release of consumer credit data, which rose $19 billion following a $20 billion increase in November.

However, after the release yesterday, the headlines were replete with commentators talking about the “end of the consumer deleveraging cycle”. Joe Weisenthal at Business Insider wrote: “It’s hard to think that the economy is going into any kind of recession with numbers like these. For the second straight month we just got a HUGE number on consumer credit. Consumer credit expanded by $19 billion in December. That’s far more than the $7 billion that was expected by economists. Revolving consumer credit (credit cards) grew by $4.1 billion sequentially, and is basically flat from last year again (up barely).

One more point on this: A lot of people think that US consumer has too much debt, and that a big number here is ‘bad’ and we could imagine that being true. But if we’re talking about cycles, and whether the economy is in rebound or recession mode, re-expanding credit is OBVIOUSLY what you want to see.”

Under more normal circumstances Joe would absolutely be correct. Rising consumer credit means more consumption, which leads to stronger economic growth. Let me explain. Individuals go to work to produce a good or service for which they are paid a finite amount of money. With that income they pay taxes, which leaves them with discretionary income on which to live. They pay the rent, utilities, insurance and healthcare bills, buy food, clothes and put gas in the car, and that pretty much consumes the majority of the paycheck.

Therefore, in the past, if they wanted to expand their consumption beyond the constraint of incomes, they turned to credit in order to leverage their consumptive purchasing power. Steadily declining interest rates and lax lending standards put excess credit in the hands of every American. (Seriously, my dog Jake got a Visa in 1999 with a $5000 credit limit.) This is why during the 80’s and 90’s, as the ease of credit permeated the system, the standard of living in America rose even while economic growth rate slowed along with incomes.

Therefore, as the gap between the “desired” living standard and disposable income expanded, it led to a decrease in the personal savings rates and an increase in leverage. It is a simple function of math.

Today, the situation is quite different and a harbinger of potentially bigger problems ahead. The consumer is no longer turning to credit to leverage UP consumption, they are turning to credit to maintain their current living needs.

Take a look at the chart of personal consumption expenditures (PCE) versus total consumer credit. Notice in the past year that as consumer credit rose, we saw an increase in PCE. In the last two months consumer credit has exploded higher, but there has been virtually NO increase in PCE levels on a month-over-month basis. Retail sales during the Christmas shopping season we disappointing, and this was even with a large decrease in gasoline prices.

This situation becomes even more apparent when we begin to look at the longer term trends of real disposable incomes, consumer credit and personal saving rates.

Most of the deleveraging process that has been occurring up to this point has NOT been voluntary. Banks have been cutting off excess credit lines, consumers have been defaulting on debt and experiencing mortgage foreclosures and personal bankruptcies. Consumers, on the other hand, are struggling just to make ends meet and are in reality doing little in terms of voluntary debt reduction. As incomes have decreased over the past two years, the inflationary pressures in food, energy, medical expenses and utilities have consumed more of that declining wage base. This is why today we have 1 out of every 2 Americans on some form of governmental assistance, more than 47 million people on food stamps, and transfer receipts making up more than 35% of personal incomes. It is hard to make the claim that the economy is on a fast track to recovery with statistics like that. That is why the recent increases in consumer debt are disturbing. The rise is NOT about increasing consumption by buying more “stuff”; it is about being able to purchase the same amount of “stuff” to maintain the current standard of living.

Yes, the economic data has certainly shown some signs of picking up as of late. However, if you ask your neighbor, co-worker or the small business on the corner about their financial circumstances the answer you get back will probably surprise you. The struggle to survive from one paycheck to the next is a reality for most American’s today. It is reminiscent of 1980, when Dolly Parton penned the lyrics for the movie “9 to 5” to wit:

Those words will certainly resonate for those in 16-24 age cohort, who weren’t even alive when the movie was made. They are part of Occupy Wall Street and are protesting the “rich man” because they feel oppressed by the system. For that age group 1 in 4 are unemployed and living back home with parents. In turn, parents are now part of the “sandwich generation” caught between taking care of kids and elderly parents. The rise in medical costs and healthcare goes unabated, consuming more of their incomes. The deleveraging cycle has been put on hold only temporarily. The recent increases in consumer debt without corresponding growth in personal consumption are concerning to say the least.

Hopefully, the recent upticks in the economic data are more than just temporary bounces following the economic crisis of last summer. Hopefully, the recent improvements in employment, while mostly temporary hires, will translate into higher incomes in the future. Hopefully, the recession in the Eurozone, which accounts for about 1/5th of exports and incomes to U.S. corporations, will not negatively impact the U.S. Hopefully, the U.S. can begin to reduce long term deficits and get the country back onto a sustainable growth trend.

That is an awful lot of hoping.

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