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Consumer Credit: What Deleveraging?

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    January 10, 2013

    The release of the Federal Reserve’s report on consumer credit was very telling.  One of the continued themes that the economy was on its way to a real recovery was that the consumer was well into deleveraging the household balance sheet.  This is important because one of the drags on economic growth has been a low savings rate due to high debt service levels.  The chart below shows “real,” inflation adjusted, consumer debt relative to incomes.  The red dashed line is the normalized growth trend of debt to incomes as a point of reference for the current levels of debt to incomes.


    What is important to note, as shown more clearly in the next chart, is that economic growth expanded when debt was lower than the normalized trend.  This led to higher savings rate which in turn fostered stronger economic growth.  However, post 1980, as the trend of economic growth began to weaken, and interest rates fell, consumers began to leverage up with debt.   The increase in debt service reduced savings rates from over 10% to less than 4% today.


    More importantly the consumer has been turning to debt to offset falling incomes.  The fight to maintain a standard of living that runs well above what can actually be afforded – has come at an economic cost.  The lower rates of productive investment, which is derived from savings, has led to a weaker trend of economic growth.  Weaker economic growth has subsequently led to weaker growth rates of disposable income.

    However, as the cost of living has continued to rise, due to both inflation and a an artificial wealth effect created by a continued fall in interest rates and stock market and real estate related asset bubbles, the affordability gap was filled with credit.  This is a problem that continues to exist.  The next chart shows consumer credit (another word for debt).


    What is clearly evident is that the only deleveraging that has occurred, so far, has been primarily due to default, bankruptcy and the foreclosure process on mortgage debt.  That is a trend, thanks to repeated bailouts of the banking sector to cover up the real issues, which is slowly fading.

    Another very disturbing trend in the data was discussed by Tyler Durden at Zero Hedge:

    “And if this was driven even remotely by actual short-term consumption demand, it would likely be a good sign, as it would imply consumers have more faith in being able to repay their credit cards. Sadly, of the entire $16 billion jump, only $817 million, or 5%, was based on a jump in revolving credit.

    The real ‘growth’ came as usual courtesy of Uncle Sam handouts, solely in the form of auto and student loans, which accounted for a whopping $15.2 billion of the increase in consumer debt, the second largest jump in the year, second only to the $18 billion in January. And as everyone knows, student loans are already on fast track to forgiveness (full forgiveness in 10 years if one works for the government), as will be the case for those NINJAs who buy GM cars using government loans. For all of 2012, a whopping $130 billion of the $137 billion total has been in the form of government handouts. In other words, nearly 1% of 2012 GDP has been funded by Uncle Sam in the form of (dischargeable) loans which everyone else will be responsible for, until nobody at all is responsible.


    “Expect non-revolving debt (i.e., student loans) to literally explode once it becomes better known that the Obama administration is preparing a wholesale debt forgiveness program as reported previously.”

    It has been quite apparent for some time that student loan debt, along with applications for food stamps and disability payments, was being used to bridge the gap between incomes and the standard of living for millions of Americans.

    With the average American still living well beyond their means the reality is that economic growth will remain mired at lower levels as savings continue to diverted from productive investment into debt service.  Furthermore, with the Federal Reserve and the Administration actively engaged in creating an artificial housing recovery, and wealth effect from increasing asset prices, it is likely that another bubble is being created.   This has never ended well before.  The concern is that without a reversion of debt to more sustainable levels the attainment of stronger, and more importantly, self-sustaining economic growth could be far more elusive than currently imagined.

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Host of Streettalk Live

    lance robertsAfter having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.