Consumer Debt: The reason the US economy won't expand.

[Proteus_MST]

And, after all.
If you already have debts, you might think twice about buying something expensive (you don´t ned at once), whereas, if you are free of debt, you might think about buying it, even if you have to raise a credit

[Case]

Originally posted by el freako
as opposed to low real interest rates - which we don't have at present

How can you not have low real interest rates? The real interest rate is the nominal rate minus inflation. Given that both US interest rates and levels of inflation are low, you should have them (if not, blame Bush )

Saying that current loans are affordable because (nominal) interest rates are low is as wrong as claiming that, because the repayments are lower, a loan repaid over 5 years is cheaper than one repaid over 3.

Again: I'm not sure what the situation was in the US in the 80s, but in the late 80s interest rates in Australia were almost 20%. These days they're about 6% Ergo, it's a lot cheaper to borrow a set amount of money and repay it in a set period of time then it used to be.

Of course, you still need to repay the same principle, and putting this off doesn't help you, but the costs associated with taking out the loan are lower. All too many economists are operating on an implicit assumption that interest rates are as high as they used to be, and as a result the debt figures are causing more alarm then they really justify.

[Gatekeeper]

Aside from a student loan payment, I, too, am debt-free. Thing is, I'm just *stingy* with my money — I usually don't go out and buy things on a whim.

I'm a "bad" consumer.

Gatekeeper

[MrFun]

Originally posted by The Mad Monk
I'm a consumer and I have no debt.

We're suppose to be impressed that you shop at Goodwill, Aldi, and Dollar Store?

[Datajack Franit]

WAY too many credit cards aka interests to pay drive people to poverty- also, don't forget all those families living with miserable wages, sleeping in carvans without any kind of public free health service

[el freako]

Originally posted by Case


How can you not have low real interest rates? The real interest rate is the nominal rate minus inflation. Given that both US interest rates and levels of inflation are low, you should have them (if not, blame Bush )

Real interest rates on medium and long term debt (5+ years) were around 1.5 to 2.5% in the 1960's in the US, they fell to negative values throughout the 1970's, rose to 4% to 6% during the 1980's and fell back to 2% to 3% during the 1990's.
Currently US 10 year bonds yield around 4%, the inflation rate (as measured by the consumption expediture deflator) is 1.8% - so that makes for a current real interest rate of just over 2% - about the average for the 1960's, however it is unlikely to stay that way over the whole of the cycle.

I think you are suffering from a common form of 'money illusion' - i'll show you an example to explain.
Imagine you borrow 3 times your annual income to buy a house over 25 years. In the first scenario the interest rate is 7.5% and inflation is 5%, during the second the rates are 5% and 2.5% respectively - so the real interest rate is the same in both scenarios.

Initially the borrower is much better off during the lower interest rate scenario - to the tune of 7.5% of income - but this advantage decreases with time as the slower growth in incomes take effect, after 10 years they are 4.9% better off, after 15 2.5% better off, after 20 0.5% worse off and after 25 years 1.3% worse off.
You still pay a smaller proportion of your income over the 25 years, but not a huge amount less (11% vs 11.8%)


How long were the interest rates at 20% in Australia, was that a peak short-term (3-month money market) rate or did that rate hold for a significant period (12 months or more) and did it apply to government debt (which is the main determinant of long-term lending rates).

[DanS]

Another thing to note is that the chart is biased. It starts at 13% rather than 0%, where it should start at. Because of this, the swings looks a lot bigger than they actually are.

[Case]

Originally posted by el freako
I think you are suffering from a common form of 'money illusion' - i'll show you an example to explain.

Erm, thanks. Stuff like that lead me to chose Economics over Commerce in university

How long were the interest rates at 20% in Australia,

Several years - Australia had something of a debt and current account crisis in the 80s, and the central bank overreacted badly. Inflation was fairly high at the time, so real rates weren't as bad as they looked.

did it apply to government debt (which is the main determinant of long-term lending rates).

Dunno. Anyway, as a small country, the Australian government's debt doesn't really affect the long term interest rates we face - the rates are roughly at the world level (+/- the risk factor), and it would take an extrodinary effort on the part of the government to even begin 'crowding out' the international money market

Case in point: Australia's highest annual government budget deficit in the last 20-odd years was significantly less then $A 20 billion (or about $US 15 billion). That's only slightly more deficit then the US government is currently running up per week!

[The Mad Monk]

Originally posted by DanS
Another thing to note is that the chart is biased. It starts at 13% rather than 0%, where it should start at. Because of this, the swings looks a lot bigger than they actually are.

I love charts like this -- they're so sneaky.

[Dis]

space exploration sucks. It's a money pit.

Yes I do believe debt is a serious problem. People are unwilling to spend any more money because their job is not totally secure and they have too much debt.

[el freako]

Originally posted by Case
Several years - Australia had something of a debt and current account crisis in the 80s, and the central bank overreacted badly. Inflation was fairly high at the time, so real rates weren't as bad as they looked.

Are you quite sure about that, according to the data I have from the OECD the annual rates for short term interest rates in Australia in the period 1986-90 were 15%, with a peak of 17.6% in 1989 (these are annual data).
For long-term interest rates the averages were 13.1% and 13.4% respectively (inflation during this period was 7.2%)

So your real interest rate has fallen from the late 1980's (from 5.5% in 1986-90 to 3.2% now) but that rate was a 'peak' value for the last half-century - and debt did not fall siginficantly then either.

Originally posted by Case
Dunno. Anyway, as a small country, the Australian government's debt doesn't really affect the long term interest rates we face - the rates are roughly at the world level (+/- the risk factor), and it would take an extrodinary effort on the part of the government to even begin 'crowding out' the international money market

I think you are confusing what the private market uses long-term bond rates for - they are a 'riskless' investment (they will always be paid back 'cos the government can always just print the money) and so the long-term bond rate in a currency is usually used for determining the rates for long-term loans in that currency.

[Kidlicious]

This thread sure got jacked good. Oh well.

I guess all I have to say is that when you are in debt you have to make payments on that debt. It has the same effect as saving money, which is the opposite of spending money. Right now the expansion depends on consumers spending.

True the interest rates are low, and that gets people to increase their debt, but there is a diminishing effect to low interest rates as debt increases.

The fact is that we will absolutely have to go through a period of paying off our consumer debt. Low interest rates aren't going to get us out of this, but low interest rates will make it easier for the govt to go into debt, and that is the only thing that will pull us out. If that doesn't happen it will be a long recession.

[The Mad Monk]

Hey, I stayed on topic -- I commented on your sneaky chart.

[DAVOUT]

According to figures mentioned by el freako, at the peak of actual interest rates, in the 80s, the debt was around 14% ; and now at the lowest point of actual rates, the debt is around 19% of annual income. So, the effect of the rates on the borrowing behaviour of the Americans would be as big as 5% of annual income. The bad news is that, as we are at the lowest point, we cannot expect the debt to increase (and consequently the consumption will not rise thanks to a growing indebtness), the good news is that when the rates will start increasing the reduction of the debt will not exceed 5%. Also, the increase of the rates will be triggered by a significant growth and the associated fear of inflation, and inflation is good for debtors.

But the idea that the economy could expand under the effect of the consumer debt is wrong, or at least excessive, in that the building up of the debt to its medium size is a one time effect, the circumstantial effect is limited to variations around the midpoint.

[Kidlicious]

Originally posted by DAVOUT
Also, the increase of the rates will be triggered by a significant growth and the associated fear of inflation, and inflation is good for debtors.

The rates are already increasing, but there is no fear of inflation now. I think the reason rates are going up is because of the budget deficit. The problem is that the deficit isn't stimulating the economy enough though because it was designed by conservatives. If the deficit would have been better designed to stimulate consumer spending then we would see higher rates and increased spending and maybe some inflation, but it would take a lot to cause inflation at this point.