$12.25 Trillion In Debt. Here’s The Good, The Bad, and The Ugly…
12.25 trillion dollars in debt…
That’s how much U.S. households currently owe to lenders. The first quarter figure is up 1.1% over the three month period, and if the growth trend continues, we should see a new all-time record when the second quarter report is released. (WSJ)
Low interest rates and steady (albeit slow) economic growth have enticed individuals across America to borrow more money, and to buy more stuff. Evidence of that spending has been piling up…
In April, U.S. retail sales were up 1.3% over March, beating economist expectations for just 0.8% growth. One of the big standouts was nonstore retail sales (code for online sales) which increased 10.2% over last year’s level.
Consumers are spending on real estate as well. This week, the National Association of Realtors reported that April pending home sales rose 5.1% which also beat economist expectations of 0.7% growth. Not only was the level of activity strong, but prices moved higher too. The Commerce Department reported a median sales price of $321,100 which is up 9.7% from last year.
Even the auto industry is benefiting from consumer spending. Last month, auto manufacturers broke an 11-year record, selling 1.51 million cars and light trucks during the month. Car sales continue to grow thanks to lower gas prices (which make it easier to justify larger vehicles), more miles driven (helped by lower fuel costs), and cheap financing (thanks to low interest rates).
Higher debt levels aren’t necessarily a bad thing for the U.S. economy. But it is important to keep a close eye on these debt levels and how they affect spending going forward. Here are my quick thoughts on how near record debt levels will play out:
The good: Low interest rates mean servicing the debt is easy.
Ever since the Fed enacted its zero interest rate policy (or ZIRP), borrowing costs for individuals have been exceptionally low. That means Americans can rack up spectacular levels of debt, without having to pay enormous monthly interest payments.
In fact, despite record levels of debt, the cost of servicing that debt (or the interest payments that consumers must make) is very low. Today, consumers must allocate just over 10% of disposable income to make payments on their debts.
For now, that’s a very manageable level, and far below the danger area (above 13%) that we experienced in 2007. So with low payments, there’s no immediate danger of defaults or a major debt crisis.
The bad: We may be borrowing form future sales.
Since consumers have easy access to credit, they’re buying things now that they might otherwise have spent years saving up for.
Case in point…
A friend of mine recently bought two used vehicles, both with price tags that were above what he told me he really wanted to spend on the cars.
Well, the dealership offered him financing for the full price of the vehicles, and with such a low interest rate his monthly payments were very low. So my friend bought newer vehicles than he would have otherwise purchased, which means he can drive these cars for years longer than he would have if he bought older vehicles.
That means in 2020 when he might have once again been in the market for another used car, he won’t be ready to sell his vehicle and trade up.
If this scenario is repeated across the country (with purchases other than just car sales), we could see higher sales today with less demand for goods and services in the years to come. That could cause some significant economic challenges down the road.
The ugly: When rates move higher, consumers will have to pay more.
One of the biggest risks I see with a record level of debt, is the increase in service payments once interest rates start rising.
The effects of higher interest rates may take some time to fully kick in. Mortgage payments, for instance, will be less susceptible to higher interest rates because a large portion of this debt is set at fixed interest rates.
But adjustable rate mortgages, and credit card balances could quickly send service costs higher once interest rates start rising. And higher interest rates will certainly make it challenging for new loans to be originated, stalling growth in consumer spending and potentially derailing the housing market growth trend.
For now, the danger of higher interest rates isn’t a pressing issue. The Fed still seems divided on whether to hike rates this summer, and even if they do tighten, it will likely be by a very small amount.
But farther into the future, high debt levels in the U.S. could lead to lower retail sales, and potentially another debt crisis if borrowing costs spike. So investors should stay nimble with their stock holdings as prices could quickly turn lower once interest rates start to rise.