The Debt Paradox

Ann-Marie Luciano Bio

In the midst of all of the grim news flashing across our computer and television screens every day, yesterday there was one bit of news with an apparent silver lining from the Federal Reserve: the total outstanding debt for U.S. households shrank in the third quarter -- the first decline in household debt ever recorded.

In terms of raw numbers, the outstanding debt decreased from $13.94 trillion to $13.91 trillion, at an annualized rate of 0.8%. The decrease is due to a deline in mortgage debt, as more Americans face foreclosures and obstacle sin obtaining mortgage loans. Interestingly, other consumer debts such as credit card debts and auto loans rose during this same period. If credit card companies continue to slash credit limits and banks continue to increase the credit score requirements for auto loans, we could see an even larger decline in household debt for the fourth quarter.

Is this a good thing? Until recently, Americans were criticized for having the dubious distinction as being among the world's worst savers. A 2006 ACNielsen survey found that almost a quarter (22 percent) of Americans had no money left after paying for essential living expenses and spending their discretionary dollars.

The problem is that Americans have finally decided to reign in our shopping-spree ways at the worst possible time. As Michael Englund, chief economist for Action Economics recently explained: "Everyone over the past three months decided to become thrifty at the same time, but our incomes depend on other people spending. If we all start saving and cut back on our spending at the same time, it means more people will ultimately get fired."

The paradox, of course, is that the more individual consumers pair down their own debts rather than purchasing new goods, the more the nation's overall debt could increase, as jobs are lost and more tax money is used to keep us afloat.

Why is it that what is good for the American consumer is bad for the American economy? I would argue that it is the fact that consumer spending accounts for two-thirds of the U.S.economy. Our economy relies on consumers to incur debt to buy things they can't afford or don't need, which we consumers gladly oblige in the good ol' American way (remember the post-9/11 "shopping is patriotic" mantra?).

Strangely enough, it may be that we won't see the economy begin to turn the tide until we see Americans return once again to their debt and spend ways.Whether this economic paradigm is sustainable is something to be seen.

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