Does Getting Out of Debt Mean that People Should Start Spending More?

From the Wall Street Journal this morning:

“U.S. families—by defaulting on their loans and scrimping on expenses—shouldered a smaller debt burden in 2010 than at any point in the previous six years, putting them in position to start spending more.

Total U.S. household debt, including mortgages and credit cards, fell for the second straight year in 2010 to $13.4 trillion, the Federal Reserve reported Thursday. That came to 116% of disposable income, down from a peak debt burden of 130% in 2007, and the lowest level since the fourth quarter of 2004.” (See “Families Slice Debt to Lowest in 6 Years,” http://professional.wsj.com/article/SB10001424052748704823004576192602754071800.html?mod=WSJPRO_hps_LEFTWhatsNews.)

The logic in this is that people reduce debt so that they can spend more. I think that is called a “non sequitur”.

If people (and businesses) get more and more in debt over a fifty year period (as they have since 1960) and this contributes to the worst recession since the Great Depression the objective of these people (and businesses) getting out of debt is so that they can get more in debt once again?

I thought that if people (and businesses) got themselves so leveraged up and so “over-extended” that they found themselves in serious financial trouble and were faced with foreclosure on their real estate and personal (or business) bankruptcy that what they would try and do is bring their debt more in line with their incomes so that they could manage their debt.

I thought that maybe people (and businesses) would become more prudent and try and manage their debt in a way that would allow them more “peace of mind” not having to scramble to make principal or interest payments every month.

And we read that there are 11 million people who find themselves owing more on their mortgages than their home is worth on the market.

And we read that about one out of every four individuals of working age is under-employed.

And, we read that the income distribution is skewed toward the high income end worse than it has ever been in the history of the United States.

And, we read that America is bifurcating more and more based on education and race.

And, we read that many state and local governments can’t meet their pension commitments and can’t balance their budgets so that they are cutting jobs, cutting pensions, and cutting education.

Some people are spending. Some people are using credit again. Some people are buying very nice homes. Some people are paying for very expensive educations.

But, this spending and credit extension is not across the board.

The inflation over the past fifty years created the ideal environment for debt creation. The inflation was not large enough to create a panic. From time-to-time, the inflation was not enough to really see.

Yet, from 1960 to the present time, the purchasing power of the dollar has fallen by 85%. The dollar that could buy a dollar’s worth of goods in 1960 can only buy about fifteen cents worth of goods now.

This was the perfect scenario for the creation of credit, for financial innovation, and for the growth of the finance industry.

This could not have been a better environment for the consumer culture to thrive where people could feed their insatiable appetites for goods and think that things were great.

And, now a substantial part of our economy is mired in this debt and struggling hard to get their heads above water. They don’t need to pile on more debt…they need some stability and consistency to their lives.

Yet, many are pushing to get the “credit machine” going again. The federal government is setting the standard (as it has over the past fifty years) by living way beyond its means and threatening to increase its debt by $15 trillion or more over the next ten years.

The Federal Reserve has pumped almost $1.4 trillion in excess reserves into the banking system in order to get the banks’ lending again.

We want families to be “in position to start spending more” as the Wall Street Journal article stated.

A credit inflation is just what is needed.

Each time we restart the “credit inflation” button again, more and more people seem to be in a position in which they are excluded from its benefits. They are under-employed, substantially in debt, and excluded from benefitting from further increases in prices.

This means each time the “credit inflation” button is pushed again, only a smaller proportion of the population can participate in subsequent expansion.

Maybe this is why it is taking us so long to get the economy “moving again.”

History has shown that this “show” cannot go on forever. The difficulty is in knowing just when the “show” is over.

The government is trying to start the music playing again. And, those that can are supposed to begin dancing. But, maybe this time only the financial industry will be dancing (http://seekingalpha.com/article/255748-will-the-financial-industry-dance-alone).