The new G.19 was issued by the Federal Reserve yesterday. It showed that consumer credit, both revolving and non-revolving (non-mortgage) debt, fell for the 12 out of the last 13 months, declining $11.5 billion from January to February.
On its face, the graph above shows that something unique in American life is going on, as there has never been such a sustained downturn in consumer credit before, but no number has meaning without context. The graph below provides some context, showing the cumulative growth rate in consumer credit, household debt (which includes mortgage debt), and disposable personal income.
For more context, we show a debt ratio that is familiar to everyone who is watching the course of the federal finances, public debt to GDP.
At close to .85x, the US financial condition hasn’t looked this bad since World War II, and it has many observers worried. Everyone understands how the Fed is trying to engineer an exit from highly accommodative monetary policy, but what is our policymakers’ exit strategy from highly accommodative fiscal policy? For more context, how does the household financial condition look based on a similar comparison? See below:
With a current ratio of total household debt to total income standing at 112%, the American Household makes the US government look like downright thrifty. If the ratio were to be reduced to 80%, which is where it stood at the end of 2000, another $2.7 trillion in household debt would need to be shed from the current total of $13.5 trillion. If the ratio were to be reduced to 45%, the average from 1952 to the inflection point of 1984, we’d have to work off another $7.5 trillion in debt. For more context, from its peak in the first quarter of 2008, total household debt has fallen just $318 billion. We realize that there is also a denominator in this ratio, but from 4Q2007 to 4Q2009, household income is exactly flat, so if there is any improvement to be made it will come from the numerator.
We like where the consumer credit numbers are going…and we hope the trend is sustained…but we would never underestimate the average American household’s propensity to borrow, nor the significant challenges in the deleveraging process. And we don’t want to pile on, but it is also worth mentioning that mortgage rates, credit card rates and auto loan rates are all rising. The financial obligations ratio, which has been ticking down with rates, will likely start rising again, putting even more pressure on American families. We would say that returns on savings would also rise with rates, but that assumes American families still save.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.