The Ticking Credit Card Time Bomb

For those holding out hope that the American economy can miraculously avoid a long and deep recession consumer credit is often viewed as the wonder drug that can cure all manner of economic ills. As such, this week’s report showing $15 billion growth in consumer credit was widely heralded as proof of America’s economic strength and resilience.  However, we are now suffering the after effects of too much debt, and our salvation cannot be found in more of the same. 

Credit card debt, which now stands at whopping $957 billion nationally (approximately $3,000 for every citizen) has, in recent years taken on a different role in American life. While in the past cards were used primarily to purchase big ticket items, spreading out costs over many months, they are now increasingly used to bridge the gap between cost of living and the diminishing purchasing power of Americans who have been taxed mercilessly by inflation. By buying with available credit instead of unavailable cash, consumers are not simply postponing the pain of higher prices, but compounding it by adding interest to the cost of everyday purchases.  In addition, as home equity credit is now unavailable to fund large purchases, many consumers are turning to non-deductible, higher cost credit card debt as the last remaining life line. As such, credit card debt compounds steadily, and for many borrowers, becomes increasingly impossible to pay down.

The statistics tell the tale. According to Equifax, a credit card analysis firm, people have been buying more with their credit cards but paying down less. As a result average balances jumped nearly 9% in 2007 and delinquency rates recently hit a 4-year high of 4.5%.

Also, the reliance on credit cards is preventing some of the markets salutary forces from working. With credit always an option, domestic demand remains strong despite rising prices.  Absent the option of putting more costly gasoline on their credit cards, Americans might have actually been forced to cut back on their consumption, taking some of the upward pressure off gas prices. 

It should be painfully obvious that expanded consumer credit is not evidence of improvement, but simply, deterioration. Unfortunately, when it comes to understanding the economy, there is little common sense on display.  By going even deeper into debt just to make ends meet, American consumers are digging themselves, and our entire economy, into an even greater economic hole and laying the foundation for the next major credit debacle. It’s fitting that just as both Treasury Secretary Paulson and JP Morgan CEO Jamie Dimon declared that the worst of the crisis has past, we are on the verge of kicking the whole thing into a much higher gear!

My guess is that many Americas continue to run up massive credit card debt because they have little intention of every paying it off.  Since many who are underwater on the home loans, and behind on the auto and student loans see bankruptcy as a foregone conclusion, they see no downside to pilling on as much debt as possible while the taps remain open.

Those choking on credit card debt may also be taking cheer from the gathering government campaign to bail out over-leveraged homeowners. The sheer numbers of who are afflicted with spiraling monthly payments will make credit card relief a potent political issue for crusading Congressman and Presidential candidates. After all, there are few fundamental differences between those who borrowed too much to buy houses and those who made the same mistake with consumer goods.  If the government bails out the former why not the latter?   In fact, one reason some homeowners have such large mortgages is that they consolidated their credit card debts into their mortgages each time they refinanced.  Why should renters be forced to pay off their credit card debts while homeowners have theirs forgiven? 

Soon, as credit card delinquencies rise and losses on pools of securitized credit card debt mount, those supplying the credit will finally get wise to the fact they will never get their money back.  As a result the market for such debt will dry up even more quickly than did the market for subprime mortgages.  Cards will therefore be much harder to come by and will have much lower limits then they do today.  Limited to only the cash in their wallets, Americans will finally be forced to dramatically curtail their spending, and the recession will finally gather serious momentum.

For a more in depth analysis of our financial problems and the inherent dangers they pose for the U.S. economy and U.S. dollar denominated investments, read my new book “Crash Proof: How to Profit from the Coming Economic Collapse.”