Illusion of Prosperity
One of the most compelling aspects of credit is that it allows you to live an illusion of a prosperity that you have not yet attained. You don’t have to have $25,000 to purchase a $25,000 automobile. You don’t have to have $250,000 to live in a $250,000 house. All you need is enough money to make the down payment, if any, and sufficient cash flow to make the payment.
The availability of easy credit over the last decade or two allowed people of average means to enjoy an upscale standard of living and people of above average means to live extravagant lifestyles. Our youth-obsessed culture magnifies the importance of enjoying the good life now. With credit, you don’t have to wait until you are prosperous to enjoy the trappings of success. You can experience them now when it really counts, when you are young.
Once the economy utilized credit to spur growth, continued growth required even more credit, because debt eventually has to be paid back. Debt payments do not produce economic growth. So more credit has to be created in order to sustain growth. Consequently, whenever the economy slowed down, credit was expanded through lower interest rates, longer repayment periods, and increased access to credit (lower standards for credit worthiness). Like magic, the economy would begin to grow again.
The run-up to the recent Great Recession that began after the terrorist attacks on September 11, 2001 saw record low interest rates, innovative credit instruments, no down payments, and access to credit for everyone and anyone. Rapidly increasing housing values gave legitimacy to this expansion of credit until the bubble burst. In the subsequent months, millions of individuals have been confronted with the ugly reality that the prosperity they had purchased on credit was an illusion. In the end, what they thought was prosperity turned out to be debt that could no longer be serviced.
Government economic policy in response to the recession has been to flood the economy with money, as usual. With their key interest rate at near zero and inflation at about one percent, the Federal Reserve is literally paying the banks to take the money. The Federal Reserve has also intervened in the credit markets to keep interest rates artificially low. But the banks, with lots of questionable assets still on the books, have stiffened credit requirements for loans and lines of credit, including credit cards. Twenty-five percent of American consumers have FICO scores of 599 or less making them poor credit risks and unable to get loans, mortgages, or credit cards. The money is not making it out into the economy, so there is no expansion of credit.
Consumer credit has shrunk from a high of $ 2,561.1 billon in 2008 to $ 2,415.3 billion as of May 2010. Consumers have paid down outstanding consumer debt by $ 193.9 billion dollars or 7.5% since 2008. The savings rate has increased from .8 percent in April of 2008 to 4 percent as of May 1, 2010. These statistics suggest that consumers are taking a break from credit to shore up their finances.
Some think this may signal the end of credit-induced growth (see The Economist, June 26, 2010, Repent at Leaisure, page 3 of a special report on debt) and the beginning of an era of consumer frugality, a “New Normal” as some in retail marketing refer to it. It is probably too early to tell if consumer responses to hard times will become a trend that continues into a stronger economy. That will require a change in values, not just a change in behavior.
Will those who once lived an illusion of prosperity choose to exercise the discipline to live beneath their means to get out of debt and accumulate savings? It is happening every day. Will there be enough of them to change the paradigm? I hope so. The economic survival of the country may well depend upon it.
K.C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages.
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