That Ticking Noise You Hear in Your Wallet is a Credit-Card Time Bomb

By Peter D. Schiff
Guest Columnist

For those holding out hope that the American economy can miraculously avoid a long and deep recession, consumer credit is often viewed as the wonder drug that can cure all manner of economic ills. As such, last week's report showing that consumer credit grew by $15 billion was widely heralded as proof of America's economic strength and resilience.

The reality is very different, however: We're already suffering from the after-effects of too much debt, meaning that our salvation cannot be found in more of the same.

Death by a Thousand Charge Slips

Credit card debt, which now stands at whopping $957 billion nationally (approximately $3,000 for every U.S. citizen) has, in recent years, taken on a different role in the life of American consumers.

In the past, credit cards were used primarily to purchase big-ticket items, enabling consumers to spread the costs out over many months, making goods a bit more affordable.

Now, however, charge cards are increasingly being used to bridge the gap between cost of living and the diminishing purchasing power of Americans who have been taxed mercilessly by inflation. By buying with available credit instead of unavailable cash, consumers are not simply postponing the pain of higher prices, but compounding it by packing interest expenses into the costs of everyday purchases. In addition, as home equity credit is now unavailable to fund large purchases, many consumers are turning to non-deductible, higher-cost credit card debt as their last remaining lifeline. As such, credit card debt compounds steadily, and for many borrowers, becomes increasingly impossible to pay down.

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The statistics tell the tale. According to Equifax Inc. (EFX) a credit card analysis firm, people have been buying more with their credit cards but paying down less. As a result, average balances jumped nearly 9% in 2007 and delinquency rates recently hit a four-year high of 4.5%.

Also, the reliance on credit cards is preventing some of the market's salutary forces from working. With credit always an option, domestic demand remains strong – despite rising prices.  Absent the option of putting more costly gasoline on their credit cards, Americans might have actually been forced to cut back on their fuel consumption, taking some of the upward pressure off gas prices. 

It should be painfully obvious that expanded consumer credit is actually evidence of deterioration – not improvement. Unfortunately, when it comes to understanding the economy, there is little common sense on display.  By going even deeper into debt just to make ends meet, American consumers are digging themselves, and our entire economy, into an ever-deeper economic hole and laying the foundation for the next major credit debacle. It's fitting that just as both U.S. Treasury Secretary Henry M. Paulson and JP Morgan Chase & Co. (JPM) Chief Executive Officer Jamie Dimon declared that the worst of the crisis has past, we are on the verge of kicking this credit mess into a much-higher gear.

My guess is that many Americans continue to run up massive credit card debt because they have little intention of ever paying it off.  Since many who are underwater on their home loans, and behind on their auto and student loans, too, see bankruptcy as a foregone conclusion, they see no reason not to just go ahead and pile on as much debt as possible while the taps remain open.

Those choking on credit-card debt may also be taking cheer from the gathering government campaign to bail out over-leveraged homeowners. The sheer numbers of consumers who are afflicted with spiraling monthly payments will make credit card relief a potent political issue for crusading congressional and presidential candidates. After all, there are few fundamental differences between those who borrowed too much to buy houses and those who made the same mistake with consumer goods.

If the government bails out the former, then why not the latter, as well?   In fact, one reason some homeowners have such large mortgages is that they consolidated their credit card debts into their mortgages each time they refinanced.  Why should renters be forced to pay off their credit card debts while homeowners get to have their debts forgiven? 

It's certainly a fair question.

But it may also be moot. Soon, as credit-card delinquencies rise – and losses on pools of securitized credit card debt mount – those supplying the credit will finally get wise to the fact they will never get their money back.  As a result, the market for such debt will dry up even more quickly than did the market for subprime mortgages. Credit cards will therefore be much harder to come by and will have much lower limits then they do today.  Limited to only the cash in their wallets, Americans finally will be forced to dramatically curtail their spending, and the recession will finally gather serious momentum.

[Editor's Note: For a more-detailed analysis of the nation's financial problems, and the inherent dangers they pose for both the U.S. economy and for dollar-denominated investments, click here to download Schiff's new financial-research report, "The Collapsing Dollar: The Powerful Case for Investing in Foreign Securities." The report is free of charge].

News and Related Story Links:

• Euro Pacific Capital Inc. Special Research Report:
  The Collapsing Dollar: The Powerful Case for Investing in Foreign Securities.

• The BBC:
  Paulson sees end of credit crunch.