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Scorched by Consumer Debt

The Federal Reserve recently reported that the amount of consumer debt in the U.S. leapt up more than 5.2% in the month of August. This was the fifth consecutive month of increases in household debt, and by far the largest rise over that time period.

While lowering jobless claims, a sinking bond market, and a rising stock market portend an improving American economy, there is something about the consumer debt trend that is absolutely terrifying.

As of August, total consumer debt levels stood at $1.956 trillion, or $18,600 per American household. These numbers do not include mortgages, which are considered separately from consumer debt. This number breaks down into two components: (1) non-revolving (includes automobile loans) and all other loans not involving revolving credit (such as payments for mobile homes and trailers), and (2) revolving debt, primarily composed of credit card and merchant card balances.

Non-revolving debt comprises 62% of all consumer debt, or $11,500 per household. That leaves $7,100 per family in revolving (mostly credit card) debt, 29% higher than in 1998. This reverses a trend from 2001 where credit card debt slightly declined. These numbers include, for the first time, debt taken on to finance education, though the past numbers have been adjusted to reflect debt held by such groups as the Student Loan Corporation (NYSE: STU  ) .

Consumer spending makes up nearly 70% of economic activity in the U.S. While pundits fret about the rising levels of federal deficits, the real terror to my mind lies in the level of consumer debt, or more directly, the lack of equity. Why was it that credit card debt dropped in 2001? Certainly the refinancing boom, which added an estimated $300 billion of liquidity into the economy, helped. What the rapid rise in credit suggests is that this money is largely spent, and the capacity for people to utilize home equity for spending is largely tapped.

What's missing here is discipline. And the frightening thing about it is that the government, in the interest of reflating the economy, is rooting for consumers to display even less discipline -- to go out and spend, to send our money to Citigroup (NYSE: C  ) , Ford (NYSE: F  ) , or Capital One (NYSE: COF  ) .

A saving populace doesn't help the economy at the moment, and apparently it's the moment that counts. But a populace that is propping up its standard of living using money it doesn't yet have in the form of easy credit is one that is at greater and greater risk. No wonder "earnings are up" at so many companies this quarter -- we're spending like we're much richer than we are.

There is an economic theory called "crowding out," generally applied to government deficit spending to boost productivity. The theory is that government spending helps prop up an economy for a period of time, but is ultimately self-defeating due to the larger and larger component of the economy then needed to service those debts.

Given American consumers' trenchant unwillingness to save, would it not hold that, in the long run, growth accompanied by higher and higher debt could cause the exact same thing?

Help do your part to bring down consumer debt. Stop by ourSavings/CD Centerfor tips on socking away money.

Bill Mann appreciates feedback at billm@fool.com.


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