Can Americans build a sustainable recovery based on borrowing money to buy cars to drive to debt-financed cosmetology classes?
Perhaps not, but they appear to be trying, driving a surprising mini-recovery in the economy and, in the process, fueling a heck of a financial rally.
Consumer borrowing in the U.S. surged for the second month running in December, rising by $19.3 billion, a 9.3 percent rise on a seasonally adjusted basis. That makes a two-month increase of almost $40 billion, something not seen in more than 10 years. The data, which doesn't include credit secured against real estate, includes a modest rise in revolving credit, such as credit cards.
The big increase, however, was in non-revolving loans, with Federally assisted education loans accounting for $8.8 billion in the month. At least now we know what happened to many of those people who have dropped out of the labor force – they are, frustrated by the difficulty of getting a job, attempting to revamp their skills. While that is better than watching daytime television, this investment in education may or may not pay off but will definitely have to be paid back.
Auto loans almost certainly accounted for much of the rest of the rise, as indicated by strong new car sales.
Tellingly, the borrowing binge came against a backdrop of dropping consumer expenditure and stagnating wages, facts that argue these are loans taken out, not in easy confidence, but in tightening circumstances. Hourly wages for production workers rose 1.5 percent in January from a year before, the smallest increase since at least 1965, the year records began. Consumer spending overall fell by $2 billion, meaning that debt accounted for a larger proportion of spending than before and financed, like as not, a fair amount of necessities, like utilities and groceries.
In some respects, this is a victory for monetary policy, as extremely low rates may finally have sparked demand. That's especially true for auto loans, where purchases of new cars have been delayed during the downturn and anemic recovery. The average age of cars on the road is a record 10.8 years.
Needing a new car, being able to get a loan for a new car and being able to sustain payments on a new car are all different things, however, and it is possible that loans which are stimulative today are non-performing tomorrow.
To be sure, all of this borrowing will have a real impact on the economy, and, by definition, is self-reinforcing. Factories will hire workers and for-profit schools will spend on marketing and instruction. The recent run of positive job figures bears this out, and it is tempting to think that the U.S. can gain confidence and enter a strong and sustained recovery.
Paul Kasriel, chief economist of Northern Trust in Chicago, notes that there is a strong correlation between the growth of credit from private financial sources and gross domestic purchases. That's because banks can, in essence, create money by making loans, allowing one person to increase spending without someone else cutting back to lend the money. Bank credit grew at an annual rate of more than 5 percent in the last six months of last year, having fallen by 0.5 percent in the first half. Kasriel thinks this will ultimately fuel inflation, forcing the Fed to raise rates in the second half of 2013, far earlier than their own forecast of late 2014.
If true, that would certainly argue for cutting back on Treasuries, which at a yield of around 2 percent on 10-year paper would suffer terribly on any inflation concerns.
What's also worrying are indications that the money being spent on debt-financed education is not paying off. The National Association of Consumer Bankruptcy Attorneys, which issued an early warning on the mortgage debacle, is now sounding off on what it calls the "Student Loan Debt Bomb."
Of borrowers from the class of 2005 who started repayments that year, 25 percent have at some point become delinquent and 15 percent have defaulted. A Chronicle of Education analysis estimates the default rate on government-backed loans at 20 percent.
While those dire figures might simply be because of the downturn, there is a danger that students are debt-financing degrees they never get, and for the holders of which there is insufficient demand. If we think about the subprime bubble we recall that the market, faced with buyers desperate to borrow money to buy houses, simply built lots of houses. That supported the economy until, well, it stopped, abruptly and violently.
The credit figures may be evidence of a new sort of desperation, not the greed of 2006 but the fear felt in 2012 by those left behind by technology and globalization.