It’s no secret that we are borrowing more and more each year, although the data does tell us that this is increasing faster than our incomes. This is not necessarily a bad thing.
Just because people’s income goes up doesn’t mean that they are better off financially. We know that there is one critical factor involved here, and that’s how much we spend.
The first stop on this road is seeing how much of our income we spend, involving both how the average person is doing, this theoretical mean, as well as how many people are crossing the line from net saving to net spending.
Our incomes tend to be fairly fixed, what we make from our current jobs for instance if our income is fixed by a salary or an hourly wage that involves a certain number of hours. Perhaps we do have the flexibility to increase this a certain amount, by working harder, either at our main job or with a second occupation, but this is also limited by practical considerations as well as the limits of our opportunities, time, and desire.
It will suffice to say that we’re stuck with a certain amount of income at the end of the week, month, or year, and while we may be able to work harder and make more, there’s usually not a lot of flexibility here.
If we’re looking to improve our balance sheets, the improvement will have to come primarily, if not exclusively, from saving more and borrowing less, which ultimately means spending less.
Our income level then becomes the benchmark, where we’re spending a certain percentage of it, including percentages over 100. When we spend more than we make, which a whole lot of people do, this creates a deficit which we either have to tap into our savings to cover, borrow, or curiously enough, do both, as some people do.
Saving for Emergencies Versus Borrowing for Them
One of the things that some people look at to measure how well we are managing our debt is to look at the percentage of people who have less money in emergency savings than credit card debt, even though we might wonder why anyone would have both emergency savings and credit card debt at the same time.
Savings and credit card debt aren’t just far apart on the interest spectrum, they are on completely opposite sides on it. Interest earned from a savings account only yields a very small amount, less than any sort of borrowing, even mortgages, and much less than the standard rates charged by credit card companies. Even the lowest rate credit cards are going to be charging quite a bit more in interest than you’d get in a savings account, which is what makes this whole thing so curious.
We’re left to speculate why people would have money in reserve in savings and not apply it to their much higher interest credit card debt, but it’s probably because a lot of people don’t properly understand that, provided they keep their credit cards in good standing and do not reduce their borrowing limits, funds needed down the road can be accessed as easily either way.
In the interim, as we hold back payments essentially, we are paying the credit card rate on our own money less what we get paid in interest, often leading to choosing to have a few thousand dollars, say, sit in the bank and get 1% on it and pay 20% for the privilege.
In any case, it seems that the number of Americans that have more credit card debt than savings is on the rise. In 2015, this number was 22%, and had dropped to 21% in 2018. It’s now 29%, and this has been trending up during the latter part of last year, and this has spilled into 2019.
This suggests that we are accumulating more credit card debt these days, although this could also mean that we are depleting our savings at a higher rate, and to see what is really going on, we need to look at the actual borrowing trends, to see if this is increasing and by how much.
Looking at Where Borrowing Rates Are Actually Headed
When we do so, we tend to look at revolving debt and installment debt separately. Revolving debt includes borrowing on credit cards and with lines of credit, while installment debt involves loans and mortgages.
Revolving debt can be used as a substitute for savings when one does need to borrow, or chooses to. Money that is paid down on revolving products can be accessed on demand, where with installment debt this cannot be done anywhere near as easily, and we’d need to refinance the debt to have more debt added or even to access some of the debt we’ve paid off on the loans already.
There’s also the matter of having to re-qualify for increases in installment debt, where we may not be approved for the increase, as compared to revolving available credit, which has already been approved.
We would expect that, all things being equal, both types would increase over time, and if they go up in the same proportion that income goes up, things haven’t really changed. We are seeing both forms of debt go up at a greater rate than income is though when we look at the numbers.
Both revolving and installment debt, as well as total debt, has been rising faster than incomes have. Our income is rising on average by 3% per year these days, and over the last 4 years, that adds up to 12%. Our debt load has risen by 21% over the last four years though, by way of a consistent and steady increase in this each year along the way.
This consistency is important to point out because this is not a matter of some change in the economy that has spurred this extra borrowing, a recession or a lot of unemployment for example, and we’d have to say that this instead is being caused by a growing appetite to borrow.
This isn’t all bad though, and while some cultures may scoff at how willing Americans are to borrow money, borrowing makes the world go around from an economic perspective, because this is how money is created. When you create more money, you create more prosperity, and the Fed will jump in and take action to make it more difficult to borrow if they want to calm this prosperity down. It should be pointed out that this tactic works amazingly well.
We therefore don’t just want to report things like Americans owe more money on their credit cards these days or that they are spending their money as fast as they make it, in a way that suggests this is all so terrible. From the perspective of the individual American, it may be, but not from the perspective of the economy.
If people were as frugal as we perhaps think they should be, and started saving for everything and borrowed only when absolutely necessary, this would no doubt cast us into a major recession or perhaps even a depression. Money supply would plummet, and the Fed would be slashing rates like they did during the Great Recession, only this time the people would not be so eager to borrow based upon lower rates because this isn’t about rates being too high, it is instead a matter of more reluctance based upon more philosophical principles.
We therefore shouldn’t be too concerned that we’re borrowing more and more each year, and these things do tend to find their own levels of equilibrium on their own, through defaults. If you actually do borrow more than you can handle, and your capacity to handle this doesn’t increase, the debt load gets written off at some point.
This does not mean that we should not carefully weigh the costs and benefits of borrowing, and that’s the only sensible approach, and it also does not mean that we should not strive to increase our savings, but this would be for the benefit of ourselves, not the economy.