Paying Off Your Credit Cards Is Killing the Recovery

Credit cardsAmerica runs on credit. Before the recession in 2008, the U.S. consumer powered the economy forward with plenty of conspicuous consumption. Housing prices were on the rise, paychecks were plentiful, and the economy purred along as people used home equity loans and plastic to outspend their incomes.

Three years seems like a lifetime ago. Since the fall of 2008, our relationship with credit has changed dramatically: More Americans have been cutting up their credit cards than opening new ones, according to data from the New York Federal Reserve. During the last 12 months, people cancelled 199 million credit cards and only opened 168 million new accounts. And since peaking at the end of 2008, the average balance has declined more than 20%.

Unfortunately, our newfound fiscal restraint is killing the economy.

Good News/Bad Economy

Let's give high-fives and promotions to the millions of Americans reducing their reliance on credit cards and paying off their high-interest debt. They're doing the best thing for their families and futures. But more money in people's pockets ironically means less overall spending in the economy.

The fancy name for this phenomenon is "the paradox of thrift." If lots of individuals start saving more money to improve their own lives, the group could actually suffer, because less overall consumption leads to lower total savings.

If MasterCards (MA) and Visas (V) get swiped less frequently at stores across America, overall consumption drops. When people stop buying homes from PulteGroup (PHM) or McMansions from Toll Brothers (TOL), overall consumption drops.

America needs some level of savings to provide investment capital for its economy. We just don't need everyone to start saving or reduce their spending, all at the same time.

It's About Confidence

As the consumer goes, so goes our economy. We want happy consumers. Scratch that: We need happy consumers. Their spending keeps our economy running smoothly. Consumer spending makes up about 70% of our gross domestic product (GDP).

During the recession, frightened households reduced their spending. As the fear subsided, consumption returned. After all, consumers who aren't worried about losing their jobs, losing their houses, or collecting their next paychecks are much more likely to swipe their plastic and maintain reasonable balances.

Unfortunately, our confidence is waning once again. Recent Gallup polls show that upper-, lower-, and middle-income groups ($90,000 is the dividing line between upper and middle) cut back their average daily spending in August as their confidence in the economy fell. This may be a short-term blip, but it's not a good sign.

Student and Auto Loans -- That's a Different Story

American consumers may have gone on a credit bender in the second quarter, but the long-term trend for credit cards still looks slightly down to flat at best. Student and auto loans, however, continue to increase.

Going to school has always been a way to improve our lots in life. A good education helps us land that first job, earn that promotion, or change careers altogether. But with American businesses pulling all of their "We're Hiring" signs from the windows, going back to school today could be a risky endeavor if hiring doesn't pick up soon.

And while it's great to see people taking out loans to buy more cars -- after all, we've got to be able to drive to work or to the grocery store -- there's a dark cloud obscuring the silver lining. As the numbers of student and auto loans have risen, so have their 90+ day delinquency rates.

Type of Borrowing
Q4 2008 delinquency rate
Today's delinquency rate
Credit Cards
10.2%
12.2%
Student Loans
9.3%
11.2%
Auto Loans
3.9%
5%
Source: New York Federal Reserve, "Household Debt and Credit Report," August 2011.

The table above is a stark reminder. Debt, even in a low-interest environment, can cause lots of problems when it can't be repaid. With many Americans still trying to dig out from under the debt amassed in the early part of the last decade, the shock of the recession has brought even more pain as delinquencies spike and bankruptcies rise.

A Catch-22?

Keeping our economy on the path to recovery and avoiding another recession absolutely depends on loosening our collective purse strings and letting the money, and credit, flow. But we must do so in moderation. If delinquency rates rise again, credit will tighten back up and spending will go back down, increasing the likelihood of another recession.

It's a Catch-22 situation: The very thing that can help the economic recovery in the short term could end up hurting it even more down the road.

To see how David is investing during these turbulent times, follow him on Twitter at @trendsandtrades. You'll have access to all his research as well as the buys and sells he's making in today's volatile markets.

The Motley Fool's David Meier is Associate Advisor for Million Dollar Portfolio. He does not own stock in any of the companies mentioned. Motley Fool newsletter services have recommended buying shares of Visa.



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39 Comments

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Hugh

Does anyone know that...if everyone did the humane thing by being conservative and living within their means...the economy would collapse? People say that we need to pay off our debts and save money, and then those same people retort by saying we need to use any saved money by spending it on anything and everything to "save" the economy. To anyone, who has any logic inside their head, this makes absolutely NO sense. Here's how it works in the most simple terms: Paper money is debt, and the ONLY reason it exist is because someone who has it owes it someone else. If Everyone paid off whomever they were indebted to, right now, money, as we know it now, would just seize to exist. Vanish. Poof! Like magic, it's gone.

November 12 2013 at 9:43 PM Report abuse rate up rate down Reply
butchiethecat

Has anyone had any problems with Capital One's credit card? I called to get a less amount of interest rate & then the next thing is a phone call from them. They stated my credit limit had been dropped down to half of the amout. I didn't asked for an increase but a lower interest rate. Just paid them off except for approximately 150.00. Had not used the card for 4-5 years paying off grandkids things. Made 2x-3x the payment. This is the 2nd time they have done this. Called to lower interest rate & they lowered the amount you I use on my card. Haven't they gotten trouble for pulling things like this?. My credit is the same as when Capital One did this again. Several months later they called me to let me know that Capital One had my amount was decreased.What should I do?
My card ws my only credit card that I use only for emergency purposes. I drove myself to Massachusetts with 2 grandkids to see my daughter before she leaves for overseas.

October 02 2011 at 1:04 AM Report abuse rate up rate down Reply
milofilonne

Whats killed this so called recovery ? It never ended to start with from GW. Oil shooting up in January and two wars eating two BILLION a week out of the treasury and its all borrowed money to start with ! The true cost of 9/11 is about 5 trillion $$$$ Any questions?

September 16 2011 at 12:49 PM Report abuse rate up rate down Reply
savemycountry911

92% of blacks believe Obama is doing a great job. They still think he'll pay their mortgage and gas bill. They could re-elect the Socialist then we'll all be strewed.

September 15 2011 at 8:28 PM Report abuse rate up rate down Reply
1 reply to savemycountry911's comment
milofilonne

I see people still like to say socialist? LOL The true socialist is COMMUNIST CHINA..

September 16 2011 at 12:51 PM Report abuse rate up rate down Reply
kv37

Thats right. Lets just keep our high consumption going. The Chinese govt is more than happy to lend us more money.

September 15 2011 at 3:06 PM Report abuse rate up rate down Reply
Dr. Jason Cabler

Unfortunately, we can't get back to being a nation of savers without some amount of pain. We "partied like it's 1999" with our credit for way too long and it's very painful when it swings back the other way.

I am extremely concerned though about the HUGE amount of credit people have run up in the last few months as found in the article you mentioned (http://www.dailyfinance.com/2011/09/12/credit-card-debt-soars-as-americans-borrow-like-its-2006/). People are feeling a huge squeeze right now and we all have to realize that a fundamental change in behavior and lifestyle has to take place.

I teach people about this in my Celebrating Financial Freedom home study course and encourage everyone to begin getting rid of the debt that is keeping them in bondage. It is the only way you can truly succeed in the long run financially. Debt is a fool's game that has eroded us as a country in many ways and we have to change what we're doing as individuals so we, as well as our great country, will be stronger in the long run.

September 15 2011 at 12:03 PM Report abuse rate up rate down Reply
jockmassage26

another RIDICULOUS piece sponsered by banks and credit card companies.. If everyone quit spending all together and if the entrie country just took a few days off of NO DRIVING, no shopping.. PRICES WOULD FALL on everything.. everytime i call an d complain about cable service.. i hear if all AT &T customers did online billing it would save 100 million trees, and 1 million gallons of gas per year.. that's one company.. if we all just stayed home and didnt buy anything.. think how much gas would be saved... prices would plummet.. we the people have the power to fight back against these big bohemeths..

September 15 2011 at 11:46 AM Report abuse -1 rate up rate down Reply
1 reply to jockmassage26's comment
georgii1

I'm going to side with the writer, because you need spending to generate jobs. Also, as spending declines cost of some services and products will increase. Just using the senior group as an example, with the hit to their retirement savings in 2008 discretionary spending decreased dramatically and that cut in spending was noticed immediately by resturants and department stores. People lost jobs. Credit cards were once a big part of discretionary spending, but with each economic scare people slowed use and started paying off those cards - and, that cost jobs too.

September 15 2011 at 3:34 PM Report abuse rate up rate down Reply
mlewis1012

Seems to me that the renewed savings culture should be rewarded...Pay the savers more interest and that will provide additional stimulus for the economy....ZIRP has doomed this economy to repeat Japan's mistakes.....Bernanke needs to be replaced or at least his policies need to be reversed....

September 15 2011 at 11:17 AM Report abuse -1 rate up rate down Reply
1 reply to mlewis1012's comment
georgii1

Well, now I'd want to know how they going to pay more interest when people are paying down (slowing borrowing) instead of borrowing to spend more. Money in saving is only worth something if someone else wants to use it.

September 15 2011 at 3:37 PM Report abuse rate up rate down Reply
1 reply to georgii1's comment
mlewis1012

Point well taken. However, If bank's costs of funds rises, they will be forced to invest in loans rather than merely borrowing from the Fed @ .25% and lend proceeds to government (taypayers) for 2%.....
And even if you disagree with this then please explain how ZIRP has helped the economy .... not merely TBTF banks and corps.

September 15 2011 at 5:42 PM Report abuse rate up rate down
Fed up Senior

Paying off your credit cards may be killing the economy, but 20% interest on credit card balances kills the individual. If our economy is so fragile that credit card debt can sink it, we need someone else in the WH to protect the economy. Maybe BO is not the one.

September 15 2011 at 11:03 AM Report abuse +1 rate up rate down Reply
l07hye

Learnt from Dave Ramsey, (Complete Money Makeover) 8 years ago, to set up a savings account, borrow from yourself, and pay back to yourself, Was the smartest thing I ever did. I also followed his other advice and we are doing alot better, than we were. Check it out Complete Money Makeover. Dave Ramsey

September 15 2011 at 10:50 AM Report abuse +1 rate up rate down Reply