The Perils of Consumer Debt

I wrote in an earlier post on our monetary system (Part II) that debt levels are crushing the world’s economy - leading to deflationary pressures throughout the world. We’re seeing more and more articles like the one below that show how current household/corporate/government debt is approaching unmanageable levels. The same dynamic is at work here that is causing housing markets to collapse – debt levels are outpacing income around the world. As the ratio of total household debt to disposable income increases – consumers have less and less money to spend. This is causing the world’s economy to slow dramatically.

Let’s first take a look at household debts levels in the U.S. (South Korea household debt levels look very similar - graph shown in the article below).

It’s easy to see that our household debt to income ratio has grown exponentially over the past 30 years. This shouldn’t be surprising to us since our debt is growing exponentially – while our income is not. Let’s take a look at some information taken directly from the Fed. The following chart shows us our interest payments as a % of disposable income.

The chart above is showing us the percentage of our income required to meet our minimum debt payments (interest only). As you can see – since the early 1990’s – the minimum payment on our debt has risen steadily and now consumes over 14% of our income. Again – this is just to pay interest – this does not reflect payment of principal. If we add in principal – we see that Americans need almost $1 for every $5 earned to pay debt obligations.


Here’s the culprit (chart below). Household credit market debt outstanding has reached almost $15 trillion dollars in the U.S. What is happening today to the world’s economy is the result of some very simply math. We can only take on so much debt – before the amount of money required to service the debt – exceeds our ability to pay (income). If you are someone faced with paying the minimum on your credit card or buying groceries – what are you going to do? You’re going to buy groceries - of course. The same dynamic is playing out all over the world – current income cannot support existing debt plus living expenses (rent/mortgage, food, etc.) – so defaults are rising on credit cards, autos, mortgages, etc. People are prioritizing what they can afford – and buying additional ‘stuff’ is not high on the list – so the world’s economy is tanking. It doesn’t matter how much ‘liquidity’ is pumped into the world’s financial system – if consumers cannot take on any more debt – there is no lending. The other piece of the puzzle – as we’ve spent a great deal of time discussing in previous articles – is that debt growth isn’t simply good for the world’s economies – it’s required.



You’ll notice that household credit market debt outstanding seems to be leveling off on the chart above. You probably also noticed that the ratio of household debt service to income ratio (chart above) actually dropped last month. I posted an article a few weeks ago that explained how Americans actually reduced their outstanding debt in November – for the first time in our history. We are now beginning to realize that more debt is not good in this economic environment – and we see this phenomenon on these graphs. The graph below shows us the percentage change (Year/Year) of household credit market debt. As we’ve also discussed previously, consumer borrowing is falling off a cliff – and since exponential debt creation is required in this system – we’ve seen the Federal Reserve taking extraordinary actions to keep the system functioning.


This is not a problem isolated to the United States. Since every major economy is on the same system – we see that every nation is struggling with unmanageable debt loads.

External Debt (% of GDP)

The world doesn’t need more debt (as we’re constantly told by our leaders) – it needs a monetary system that is sustainable.

So, we are now in a situation where deflation (prices are dropping for everything) is rippling throughout the world’s economy due to crushing debt loads while the supply of money in the hands of consumers is also declining significantly. Since debt growth is slowing and debt equals money in our system– money supply growth is also slowing.


While the total supply of money continues to grow (albeit much slower over the past few months) – who is getting more of the money and who is getting less? Who is benefiting from the trillions in bailout money as the system collapses? The wealthy – bankers, Wall St., etc. Who continues to struggle under this system – you and me. Wealth is now being transferred from average people (that’s you and me again) to the rich at a dizzying pace.

It has always been this way – we just haven’t been paying attention. We live in a monetary system that allows (our Government allows this – which means you and I allow it) banks to create money and charge us interest on the money they create. Even though this fiat currency is inherently worthless, they continue to control more and more of the world’s assets through this system while you and I have less and less. I’ll say it again – this is not an accident.

Are the bailouts having any affect on the economy? Nope. Take a look at bank reserves at the Fed.


These excess reserves tell us that banks are not lending the money they are receiving – regardless of what we’re told through the media. This is due to the current state of the economy and the fact that the Fed is paying interest (.25%) on reserves.

How are credit markets? It appears that the Fed remains the lender of last resort.

Although we continue to hear lots of rhetoric about ‘reviving’ the economy - we are seeing economic conditions continue to deteriorate and we see the Fed and Treasury doing very little to help. The Fed lowered the Federal Funds Rate target to .25% yesterday – which simply matches the effective Federal Funds Rate – it’s actually been around .25% for months. Lots of talk – yet they are doing nothing to actually correct the situation. I don’t have to tell you again how this ends.

By the way – if you’ve heard the Fed talk about ‘Quantitative Easing’ and wondered what this means – it simply means that the Federal Reserve is planning to print vast amounts of dollars. If you’re thinking this could seriously devalue the dollar – you’re right.

jg – Dec 17, 2008
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DECEMBER 17, 2008

The Perils of Consumer Debt on Display in South Korea
By EVAN RAMSTAD

Wall St. Journal

SEOUL -- After the Asian financial crisis hit South Korea a decade ago, the government helped the export-dependent economy recover by pumping out money and convincing people to borrow and spend more.

But this time around, the high household debt that accumulated in the past decade is depressing spending -- an experience that has relevance around the world as governments seek ways to get consumers to help lift their economies.

A supermarket in Seoul, where debt is up and spending is down.
As exports drop and South Korea's economy slows, a high level of household debt is keeping consumers from spending more and the government -- like others elsewhere -- is wrestling with the question of how much to intervene.

South Korean lawmakers over the weekend approved a 2009 government budget that is 11.5% larger than this year's, at 284.5 trillion won ($208.65 billion). On Tuesday, the Ministry of Strategy and Finance unveiled a package of job programs and spending measures it calls the "South Korean New Deal."

The debate in South Korea is also colored by its unfinished rise from poverty, which began in the 1960s and proceeded strongly until the Asian crisis. In the aftermath, South Korean companies wiped out debt, built up cash and invested less in the economy, while the government eased consumer borrowing.

That led to a steep rise in consumer debt. Now, as the global slowdown erodes South Korea's ability to export goods, domestic consumption is too weak to drive economic activity the way it did in the late 1990s. The government expects private consumption to grow just 1% next year.
"Everybody is too much in debt, so they cannot consume," says Kim Kyeong-won, a senior vice president at Samsung Economic Research Institute.

According to data released by the Bank of Korea last week, South Korean household debt climbed 10.7% in the third quarter from the same period a year ago to a high of 676 trillion won. That amounts to 40 million won, or $29,300, per household.

South Korean government and banking officials acknowledge household debt levels are high but note that delinquency rates are low, and that falling interest rates are easing some of the pain. The central bank has lowered its main rate to 3% from 5.25% over the past two months.
Meanwhile, tight restrictions on mortgages -- consumers can only borrow up to 60% of the value of their property -- should insulate banks if defaults rise or property values fall.

The government's policies for 2009 are based on an expectation of 3% economic growth next year, said Noh Dae-lae, a deputy finance minister. That's higher than the Bank of Korea's forecast of 2%. Some private economists predict a contraction for the first time since 1998.

The consumer-debt problem is entering the debate over whether the South Korean government is too involved in the economy. President Lee Myung-bak campaigned last year on a platform of scaling back government involvement, including cutting regulation and privatizing some government companies. The prospect that Mr. Lee will instead preside over more intervention is widely debated in the parliament and media.

In South Korea's crisis a decade ago, the government propped up failing businesses and banks, and it remains a big shareholder of some of those firms today. And as consumer debt grew over the past five years, several new government programs emerged to help people avoid bankruptcy, which carries a social stigma.

At a credit-counseling center that is part of one such program, Yoon Sook-hyeon recently appealed for a new repayment schedule after an illness kept her from making six months of payments on a $27,000 debt-workout program she started three years ago. Ms. Yoon, a divorced mother of four, ran up the debt when she started putting expenses from her family business, a small motel in Seoul, on personal credit cards.

"When I started using a credit card, it was just for living costs, education fees and clothes for the kids," Ms. Yoon says. "When the business got worse, it was hard to pay the bills so I got cash from credit cards. Then it got more difficult, so I had to use several cards together. Later, I couldn't even do it." A credit counselor listened to her story for about 30 minutes and agreed to extend her program.

Jung Sook-cha and her husband have run up nearly $70,000 in education-related loans, which allowed one of their children to study overseas. She said she's worried her husband, who works at a bank, may be forced to take a pay cut in the slowing economy, hurting their ability to maintain loan payments of $1,000 a month.

—SungHa Park contributed to this article.
Write to Evan Ramstad at mailto:evan.ramstad@wsj.comm