Our Nation is Addicted to Debt

As I mentioned in episodes past, [Margin] is focused on a strategic approach to personal finance. I have built this to be linear to help the audience improve their finances daily. This month’s theme is debt; yes, debt. I placed this at the front of the transformation process because so many feel buried by it.

Debt is one of those aspects that people are scared to look at and talk about, so let’s get into this debt thing as though you are having this discussion with yourself.

You’re looking at yourself in the mirror and, consequently, your debt. This practice comes without the concern of feeling like you are opening up to someone else about your failures. I know that is an unpopular topic to jump into; we can all admit that most people have a visceral reaction to this topic. That is precisely why the discussion is necessary. 

The introduction episodes of [Margin] provided you with my inspiration for building margin in my own life and helping others build that same margin. Much of this inspiration came from first-hand experiences helping people walk through the situations they were facing. So many have mortgaged their futures and cannot see the light at the end of the tunnel. There is hope, though! As we enter into a new year, this is a perfect opportunity for you to deal with what you probably don’t want to address: debt.

In 1971, President Richard Nixon halted the U.S. dollar from having an underlying value tied to gold, otherwise known as “the gold standard.” This action has rapidly expedited the use of debt as a means of economic growth, as banks leverage deposits to create loans. The most recent data shows that banks hold a leverage ratio of 8.80, meaning that for every dollar of bank capital requirements, that dollar uses almost 9X to fund loans. Banks have seemingly been in the zone of being considered healthy, or a ratio above 5%, for the last ten years. The Federal Reserve also reported that half of 1% of banks were not well capitalized as seen in the increasingly improving environment for bank leverage below:

So if banks are healthy overall, how is the country at large? An article by the Federal Reserve Bank of St. Louis states that “In the second quarter of 2008, U.S. federal debt held by the public totaled about $5.3 trillion, or 35% of gross domestic product (GDP). This figure grew to $20.5 trillion—or 105% of GDP—by the second quarter of 2020. To put it another way, the national debt has increased 400% in 12 years, while over the same period, national income has grown by only 30%.” Might I add this GDP level going into the second quarter didn’t last long; by the end of the second quarter, the nation’s GDP surpassed 135%.

The article went on to say, “When the interest comes due, it can be paid in legal tender—that is, by printing additional U.S. or Federal Reserve Notes. It follows that a technical default can only occur if the government permits it. The situation here is similar to that of a corporation financing itself with debt convertible to equity at the issuer’s discretion.”

Currently, America is $27.5T—yes, trillion—in debt. The more considerable concern at play is that America has a debt-to-GDP ratio of 127%, which broke the 1946 World War II record in mid-2020. This ratio means that for every person living in the U.S., there is $83,207 of national debt. The debt-to-GDP is especially crucial to the ongoing concern of the U.S. and the ability to stay solvent. However, America can simply print currency to prevent default in the short term. So if America can print money, and less than 1% of banks are not adequately capitalized, where does that leave the American consumer?

We Are Addicted to Debt

We all know that we tend to be a product of our environments. With banks working tirelessly to figure out new and innovative ways to create debt vehicles, our nation\’s love of owing money keeps the American consumer in debt. But how bad is the actual picture?

Business Insider wrote an article deriving information from the Federal Reserve Bank of New York stating that; \”The average American debt totals $51,900.\” That includes mortgage loans, home equity lines of credit, auto loans, credit card debt, student loan debt, and other debt, like personal loans.\”

According to the Federal Reserve, the aggregate household debt balance was $14.35T in the last reported quarter of 2020. As expected, mortgage debt at 69% is almost three-quarters of the debt held by the average household, followed by student loans at 11%, auto loans at 9%, credit cards at 6%, and another 6% in totality on revolving home-equity lines and other debt. These statistics are staggering nonetheless, especially looking at this debt regarding 80% of the population living paycheck to paycheck, with little-to-no savings.

Stepping out of the heavy spending months of Q4, it can be a bit scary to look at how much we actually spent. It is estimated that the average American spends almost $1,000.00 on Christmas gifts. The National Retail Federation spoke of pent-up demand due to the challenging year and earlier gift purchasing, increasing spending between 3.6 and 5.2 percent over the prior year. This stat shows that many of us spent more than we usually do. So why am I telling you all of this? It relates to my previous statement: 60% (199 million) of Americans cannot cover a $1,000.00 emergency without going into debt. This means the average person financed the holidays with debt. You may be asking, \”so what?\” Most people use their credit cards to fund Christmas then work to pay them off at a later date. 

Americans are addicted to debt, now more than ever. Ray Dalio says that credit is the most important part of the economy. When taking advantage of credit, there is a principal and interest payment. You can increase spending when you get increased credit.

Let me ask you this: can you afford the lifestyle you lead? Not \”can you afford the payments,\” but can you afford to purchase the items you enjoy without using debt?

Credit, much like money, is not bad in and of itself. Credit isn\’t good when it fuels over-consumption, especially over-consumption for goods and services that don\’t improve your specific quality of life. 

It\’s no new news that we have experienced a long cycle of growth and expansion. We\’ve gotten comfortable. When we are comfortable, debt grows as credit is easy. The problem comes when the tide goes out. Dalio explains that one person\’s spending is another person\’s income, but income drops if spending drops.

A line-of-credit, payday loan, or other personal loans are typical. What type of high-interest, unsecured loans do you have?

Credit Cards are Not Your Emergency Fund

My gosh! Everyone seems to love to talk about this topic, especially when it comes to outsmarting the system, playing credit card arbitrage, or only using it for the points. The Balance recently reported that; “Revolving debt set a record of about $1.1 trillion in February 2020. That was higher than the previous record of over $1.0 trillion set in 2008.” Do you think this industry isn’t highly funded to feed on American spending habits and marketed to catch even the most suspectful among us?

I remember when I got my first credit card offer as I was heading off to college; in fact, I still have that card. I remember some 0% promotion where I purchased a bunch of car accessories, parts, and clothes on it without blinking an eye. I am no credit card saint; I have had my fair share of spending far too much on my credit card. It took months, even years, to finally pay off those car accessories and clothes I “needed.” It has been proven that we spend more with plastic than with cash, being that cash physiologically triggers the pain centers in our brains. 

An article by an affiliate of Lending Tree said, “that people are willing to spend more—as much as 83% in some cases—when paying with a credit card instead of cash.” 

Credit cards should not be your bailout plan, whether they be for purchases or cash advances.

Credit cards can indeed be an excellent way to build credit, but WalletHub states that the average credit card rate is at almost 18% for new credit lines and nearly 15% for existing ones. This stat should be eye-opening when the prime rate is about 3% higher than the federal funds rate, which is between 0.00%-0.25%. Case in point—credit cards are making out like bandits on your revolving balance.

I am in corporate finance and have two credit cards, but these are just to have open revolving credit lines (being that my credit score may be part of the vetting process in a finance position). I have kept these accounts open with an auto payoff monthly to ensure that I am not holding a balance and accruing interest. You may also encounter a position where an employer will be especially interested in your credit rating to make sure you are personally healthy for the role for which they are looking to hire you. 

So today, log in to each of your credit card accounts and take note of the total payoff of your store cards, credit cards, gas cards, and the like. Don’t just look at your own credit card balances; examine your dependents, spouse, children, or relatives’ balances for which you are a signer. I often hear of folks who only check their own credit card balances, separating those in their household or those they have co-signed for—don’t do this! Inspect it from a holistic viewpoint.