Consumers are once again turning to borrowing—and they’re doing it in significant amounts. Recently, the Federal Reserve revealed that consumer credit surged by $19.3 billion in December, which far exceeded the $7 billion median estimate from a Bloomberg News survey of economists.
This $19.3 billion spike came on the heels of a $20.4 billion increase recorded in November, marking the largest two-month rise in consumer spending in over ten years. According to the Fed report, non-revolving debt—such as auto and student loans—accounted for $16.6 billion of this increase, while revolving debt, primarily credit cards, contributed an additional $2.76 billion.
The trend of consumers accumulating debt at pre-recession levels raises questions. Have they truly lost their sense of judgment again?
“Not just yet,” remarks Alan Levenson, chief economist at T. Rowe Price in Baltimore.
He points out that December’s total revolving credit stands at $801 billion, significantly less than the peak of $972 billion observed in August 2008.
“If you examine another metric, the overall consumer credit of $2.5 trillion is currently 21.5 percent of after-tax income—close to the lows of the late 1990s,” he says.
“‘We’re still far from the cyclical peak,’ he adds.”
Relying on Numbers
That may be true. However, despite officially being in recovery since June 2009, the economy appears weaker than diluting a glass of Budweiser. Will consumers ultimately drive the economy forward?
The answer largely hinges on how much trust you place in statistics. A government economist might highlight that consumer spending represents 70 percent of the economy. By this logic, they could deduce that a rise in consumer credit is beneficial, potentially spurring an increase in gross domestic product.
At Economic Prism, we are more concerned with the implications behind the numbers than the figures themselves. Economic growth driven by rising consumer credit is generally not cause for enthusiasm. An increase in GDP fueled by debt accumulation doesn’t signify true economic progress; rather, it indicates the pace at which the economy is heading toward instability.
Nonetheless, the aim of monetary policy since the onset of the 2007 recession has been to encourage consumers to spend on credit. When the federal funds rate was initially reduced to near zero in late 2008, many anticipated that a vibrant economic boom was imminent. However, aside from rising stock prices, that boom never materialized.
Post-2008 credit crisis, banks were extremely hesitant to extend more of the Fed’s cheap loans, resembling a diabetic’s aversion to sugary treats. The prevailing fears and stricter lending standards following the real estate collapse led banks to retain cash rather than circulating it into the economy. Instead, this new money either accumulated on bank balance sheets or was used to purchase government debt.
This indicates that the Fed’s monetary policy failed to generate the desired stimulative impact on the economy—but this may be changing now.
The Illusion of Momentum
As noted earlier, the Federal Reserve has reported the largest two-month increase in consumer debt in over ten years. This shift suggests that credit is beginning to flow back into the economy, a trend not seen since mid-2008 or earlier.
However, it’s crucial not to be misled by this apparent boom. It is not a genuine surge based on savings and capital investment; rather, it’s a misleading boom fueled by consumption driven by cheap credit. The sooner this illusion dissipates, the better it will be for most—except for President Obama.
The success of President Obama’s reelection efforts may hinge on how robust and enduring this false boom turns out to be. On the bright side for him, consumers have rekindled their enthusiasm for making unnecessary purchases with borrowed funds. Moreover, the bond market continues to allow the government to borrow against future revenues to fund current expenses at little cost.
Recently, at Northern Virginia Community College, Obama unveiled his 2013 budget proposal. We had hoped for a balanced budget; however, despite all the proposed tax hikes, there still looms a near trillion-dollar revenue shortfall. Clearly, those managing the numbers are struggling to grasp the concept of addition. Regrettably, those who have diligently saved will ultimately bear the brunt of this fiscal mismanagement.
In the short term, stock markets might face a brief correction before experiencing a resurgence. Indeed, these deceptive booms can be exhilarating while they last. Yet, when the next downturn inevitably arrives, public reaction may be reminiscent of the chaos witnessed in Greece.
Sincerely,
MN Gordon
for Economic Prism