Debt and the American Economy

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Consumer debt is the credit extended to individuals. This excludes the debt held by the government and comes in the form of home mortgages, auto loans, credit cards, student loans, and personal loans. While consumer debt helps fuel economic growth, the global economic decline can be attributed to the consequences of hoarding too much debt with the inability to meet debt obligations. Consumer lending and debt that are controlled in a rational manner help boost the economy to experience consistent growth. Consumer lending and debt that is inherently irrational does have short term benefits; however, those benefits are overshadowed by long term consequences. Nonetheless, consumer lending and debt support economic growth at least in the short run.

The majority of the important macroeconomic dilemmas are centered on the behavior of consumers. Consumer spending accounts for a significant portion of the American Gross Domestic Product (GDP). Therefore, the primary source of the United States' growth in the economy is consumer spending. Consumer spending (Business Dictionary, 2013) is “goods and services bought by households in the satisfaction of their needs and wants. It includes non-durables such as food, semi-durables such as clothing, and durables such as refrigerators.” At the macroeconomic level, consumer spending is the largest driver of economic consumption and takes up the lion’s share of the demand side of the supply-demand equation on a National economic landscape. Consumer debt is, therefore, a macroeconomic force that supports consumer spending. 

Regardless of economic condition, there is always a demand among people to obtain additional money. The class structure and media encourage an environment where people are in constant pursuit of material wants as opposed to only purchasing those items they need to sustain life. Consumer debt is a method of installing credit purchasing with the consumer in order to obtain items in the economy. Therefore, consumer debt allows consumers to make purchases that they normally wouldn’t be able to make with cash alone. Of course, consumer debt must eventually be paid off in a combination of principle and interest on that debt. 

Critics argue that consumer debt and spending does not fuel economic growth. This argument is driven by the notion that resources are limited and finite. As a result, critics argue that spending alone cannot support the economy; the economy must be actively producing more goods and services. Therefore, economic growth is really growth in productivity within the economy. According to Mandel (2013), “the money that people actually pull out of their paychecks and bank accounts to pay for domestically-produced goods and services drives about 40% of economic activity in this country. That’s still large - but the U.S. is nowhere near as dependent on consumer spending as people think.” While this is an interesting argument, it isn’t supported with a credible level of scholarly research. 

Consumer debt levels in the American economy have grown over time; however, recent events have shown a decline over the previous few years. This decline in consumer debt shows a correlation with the lack of economic growth. According to the Federal Reserve (2013), the total household debt of the United States during the first quarter of 2013 was $10.49 trillion. At the time of the economic recession in late 2008, the consumer debt level was 13.45% (Federal Reserve (2013). The Federal Deposit Insurance Corporation (FDIC) has also studied consumer debt and lending over time. According to the FDIC (2013) “despite strong growth in disposable incomes, consumer balance sheets have become stretched by large amounts of new debt—over $1.1 trillion in the last year and a half alone. This rapid increase in consumer spending and borrowing raises important questions about the sustainability of current debt loads and the vulnerability of the consumer sector to economic shocks.” Consumers have responded to the new debts and the overall condition of the American economy by restricting new debt spending. This phenomenon has worked to delay the rebound from the recession as consumer spending is what drives economic growth. 

Consumer debt, as a part of the economic cycle, finds its way into the corporate world in the form of enhanced profitability. Therefore, consumer debt increases the posted success of businesses in the form of financial statement cash and receivables. According to Baragar and Chernomas (2012), “the debt borne by working-class households in Canada and the United States has risen in the late 20th and early 21st centuries. This debt has opened a channel through which value created in the non-financial sector is transferred to financial firms, thereby enhancing the profitability of the financial sector itself while simultaneously raising the rate of exploitation of labor.” Consumer lending has a profound effect on macroeconomic developments and capital accumulation of businesses operating within the U.S. economy. 

It has been commonly reported that the average American citizen is in $9,000 worth of credit card debt. A quick trip to a Statistics 101 class will show that averages can be very misleading. The average calculation simply takes all of the credit card debt owed by the American citizens and divides out that debt among the people old enough to take on credit card debt. The best measure of credit card debt is to take the statistical median, which is $2,200 (Credit, 2013). Consumers have stepped back from their old spending habits in response to the economic recession (Credit, 2013). The reality is that consumer lending is vital to the growth of the economy. In the short run, consumer lending causes an increase in consumer spending by allowing debt holders additional funds for goods and services that they normally wouldn’t be able to obtain. In the beginning, this additional spending has a good effect on the economy as the additional cash begins to circulate in the markets. The initial benefit of the increase in consumer lending and spending is a temporary economic gain that has consequences as the debt increases. When the debt reaches a level that is unhealthy, it is oftentimes not able to be paid back and a default occurs. On a macroeconomic level, there are tremendous consequences of large groups of consumers defaulting on debts. This is shown in the recent economic collapse as a result of mass mortgage defaults. 

The last economic recession was drastically different in regards to household debt. The last economic recession in 1982. According to Brown, Haughwout, Donghoon, and Van Der Klaauw (2013) when the financial markets collapsed in 2008, the national household debt to GDP ratio was almost 100 percent…At the time of the 1982 economic recession, the national household debt to GDP ratio was 45 percent. This equates to a very different situation because consumers could spend their way out of the previous recession and they simply cannot today. “Since the onset of the financial crisis, households have reduced their outstanding debt by about $1.3 trillion” (Brown et al, 2013). The cyclical nature of the economy can resume at 45 percent household debt. The remaining life vest is the government. In order for consumers to spend their way out of the current recession, the government must be able to intervene in some way. During the 1982 recession, the Federal Reserve also lowered interest rates in an effort to encourage consumer spending and a consequential economic recovery. Today, the interest rates are lower than ever and consumers have not been able to spend the way out of this recession because debt levels are maxed out. Regardless of the incentive provided, there isn’t enough debt capacity to get out of the hole. The appropriate label for this recession, and its barrier to the good, is household debt levels. The answer to the economic dilemma, therefore, is government intervention to encourage consumers to be able to pay off debt. This can be accomplished by giving tax cuts and improving unemployment through job programs. The other public policy, besides tax cuts and unemployment, is to write off debts or forgive debts through principle reduction. According to Sufi (2011), who is an economist at the University of Chicago, “the high level of household debt is holding back the U.S. economy because consumers are focused on paying off debt and are not engaging in historic consumption levels.” Sufi (2011) continues to argue that mortgage write-downs are needed to restart the economy when household debt levels are too high. 

The global economic picture is dismal; however, “the U.S., for its part, has decent economic fundamentals – consumer debt is down, spending is up, the housing market is bottoming out, and a homegrown gas boom is creating jobs and will eventually make energy a lot cheaper” (Foroohar, 2012). The U.S. economy is growing at a snail’s pace; it’s still growing positively. There are also some positive characteristics of the economic recession in terms of improvement in the level of household debt. According to Krainer (2012), consumer debt levels have declined over the course of the economic recession since 2008. A vital ingredient in any economic growth or recovery is the increase in consumer spending that is fueled by consumer debt. The relationship between economic recovery and consumer debt shows the inability of the American economy to get out of the recession is correlated with consumer debt levels decreasing over the previous five years. According to Stanford (2011) the reliance of household debt on fueling any type of solid economic recovery is “shaky.” The combination of consumer debt and spending with governmental spending is needed to support strong economic growth.

Some debt is bad and some debt is good. Good debts are considered investments that will increase in worth or generate additional income such as interest. For example, the use of debt to acquire a college education and increase future income is good debt. Student loans usually experience low levels of interest over time versus other forms of consumer debt. The debt transforms into a higher level of human capital that can be used to acquire raises, bonuses, or another job that is higher paying. Another form of good consumer debt is financing a home mortgage. While the economy is still reeling from the latest housing market crash, mortgages should be considered good debt if purchased correctly. The housing market crash was fueled by high levels of consumers taking out more debt than the home was worth and then defaulting on that debt. In essence, they had built no equity to help make it through the tough times. When enough citizens defaulted on their homes, the bubble collapsed. This spark brought down the entire market and the American economy hasn’t rebounded since 2008. In a responsible way, purchasing a home using a mortgage is a good type of debt. Similar to college education loans, a mortgage usually has a lower interest rate than unsecured debt tools and the interest paid on a mortgage is tax-deductible. In addition, paying off the debt over time increases equity by owning that portion of the property that is paid. Smart homeowners will pay off their mortgage timely, at a low interest rate, and the home value will increase enough to mitigate the interest paid over the course of the loan. 

Purchasing a vehicle with credit doesn’t provide equal benefits as a home mortgage; however, it is still considered a good use of credit. The essential nature of vehicles for travel and business mitigate the decrease in value of a car over time. Vehicles are less costly than homes so it’s easier to make significant down payments or use cash as a form of purchase. Another form of debt that can be considered positive is a home equity loan. This type of loan isn’t as good as a mortgage or vehicle loan, but if used wisely, they can help the user pay off other forms of debt that are more costly or weather a personal economic dilemma. 

Bad types of consumer debt accrue when the items purchased with debt lose intrinsic value or aren’t used to generate any additional income. Bad debt is also characterized by high levels of interest that must be paid correlating with the principal. The worst forms of debt are credit cards and payday cash advances.  Payday cash advances usually have extremely high fees and interest on the amount of the loan and they must be paid back quickly. The interest paid for payday loans is known to be outrageous. 

Credit cards are such poor tools because the actual amount paid over the course of paying off the debt for any item usually renders that item’s real cost artificially high. Many consumers confuse needs and wants and simply use credit cards to obtain items in which they do not need. According to Majid (2010) “credit cards clearly have an adverse impact on some consumers. Consumer behavior that causes these adverse consequences can best be explained by behavioral economic theory. Since consumers have documented biases which make their behavior inherently irrational, the rational economic model is unable to accurately explain or predict consumer spending behavior.” Therefore, without some type of intervention, consumers will inevitably increase consumer debt levels in the U.S. economy over the long run. According to Jiang and Dunn (2013) consumer behavior patterns show different levels of spending within different cohorts. – “Younger consumers are found to be borrowing more heavily and repaying at lower rates than older generations. The accumulation of credit card debt is found to continue over the lifecycle. This has implications for recent changes in laws governing the credit card industry.” Essentially, the focus has turned on the industry-changing instead of the consumer; almost as if the consumer cannot be changed due to the inherent irrationality in credit card use. 

Researchers tend to agree that economic growth is contingent upon two things – governmental and consumer spending. According to Kedrosky (2012) “the best way to restart global growth is with debt.” The argument is that developed nations, like the U.S., need to manage debt to lower levels as it is at the point of providing economic consequences. On the other hand, developing nations could use higher levels of consumer lending and debt to fuel international economic growth. The developed debt is restricting economic growth as its citizens are cutting back on spending and paying off debts as quickly as possible during the recession. Governments like the U.S. are not making up the spending difference. In fact, the U.S. has to push back the debt ceiling every few months and is currently under a governmental shutdown. At this time, developed governmental spending is restricted as individuals are also petitioning politicians to limit spending and grow more responsible with taxpayers’ money. The economic dilemma is that the cash being used to pay down consumer debt is being borrowed from what once was spent on consumption. According to Kedrosky (2012) “with the United States and European banking interests together accounting for half of global GDP and with consumption making up 70 percent of U.S. GDP, we have a math problem: No matter what innovations are introduced, no matter what entrepreneurial ideas are tried, there aren’t enough customers for the U.S. to export its way out of the self-imposed austerity that comes with deleveraging.” Therefore, while consumer debt has consistently been employed as a mechanism of economic growth, that very mechanism, over time, becomes a consequence because the growth cannot go on forever. The debts must eventually be paid or written off. Something has to give. 

Some researchers believe that the economic growth experienced as a result of consumer lending will eventually lead to economic consequences. According to Lim (2005), the really significant consequences of amassing incredible levels of debt will be realized when interest rates rise again. Recently, interest rates have been smashed to very low levels due to the Federal Reserve stimulus policies. For quite some time, the prime rate has been nearly zero. In the event that interest rates rise to any substantial level, the economy can expect consumers to begin defaulting on their debts. The Federal Reserve started lowering interest rates in 2004; and since then, rates have been suppressed to historic low levels for historic amounts of time (Lim, 2005). While the Federal Reserve has tried to stimulate the economy, it pales in comparison to the effectiveness of consumer spending. Some might say the Federal Reserve is trying, yet failing. According to Steil (2012) “the Fed (Federal Reserve) has driven its short-term lending rate down to zero, most banks will only lend on vastly greater collateral and at much higher real interest rates than before the bust. So the Fed plows on with the cheap and easy macroeconomic option: flood the pipes and see what comes out.” This strategy is in an attempt to replace the liquidity once seen, prior to the economic collapse, in real spending of real cash and consumer lending credit.  

The current economic recession shows a pattern of consumer borrowing and spending that is unlike any other recession that has been scrutinized. This leaves scholars to wonder if the consumers have reached their capacity when it comes to debt obligation. One scenario that is plausible is that consumers have become burdened by high levels of debt and there is a macroeconomic shift to pay off the debt in lieu of spending on items that are discretionary. Corporate credit card companies may be worsening the situation by aggressively allowing high-risk borrowers to gain access to credit that will eventually be defaulted. According to the Federal Deposit Insurance Corporation (2003) “Five significant trends in consumer lending, some of which have been developing for years, coalesced during the 1990s to profoundly alter the consumer lending environment. These trends are deregulation, general-purpose credit cards, credit scoring, pricing according to risk, and securitization. Together, these trends have given consumers unprecedented command over economic resources.” In order to benefit from the consumer lending revolution, all stakeholders must work to instill a rational behavior pattern back into the marketplace. 

Economic growth can be supported by two factors – consumer and governmental spending. The American economy is driven primarily by the behavior of consumers in the market. Consumer spending and acquisition of debt that is rational and controlled works to support the overall economy and supports healthy economic growth. Consumer debt can be broken down fundamentally into two groups – good debt and bad debt. Good debts such as student loans and responsible mortgages have short term benefits in stimulating the economy. Bad debts such as payroll advances have dire consequences on the macroeconomic level as they overly restrict future spending even in the short run. Regardless of the overall economic health at any given time, there will always be a need for monetary spending. The irrational use of consumer lending and debt does have short term benefits, but those benefits will eventually end with long term consequences. While critics argue that consumer debt does not support economic growth, this assumption is not backed by an array of scholarly research. On the contrary, there is strong support of the concept that economic growth, at least in the short run, is fueled by consumer spending, and furthermore, by consumer debt. The increase in consumer debt lends itself to find a way into the balance sheets in corporate America in the form of sales revenues and accounts receivable. The current economic recession is special and requires a special response. Historic recessions have been overcome through an increase in consumer lending, incentives, and spending. Consumers today have absorbed twice as much debt and simply cannot spend the way out of the recession. Government intervention in debt downsizing and write off will be required to escape this economic dilemma. 


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