I've noticed an interesting multiplier effect in recent weeks: Every government-sponsored remark about jumpstarting credit amplifies media criticism by what seems to be double-digit factors. At the heart of the debate, I see opposing views on the most effective first step toward healing the economy. Should we hunker down and save, save, save, or ratchet up and spend, spend, spend? I know that moderation doesn't make for an entertaining rant, but the truth just might be somewhere in between.
A portrait in extremes
Imagine a world without credit. Want to buy a car so that you can commute to that new job across town? No problem, but when you stroll on over to the local Toyota (NYSE:TM) or Honda (NYSE:HMC) dealership, make sure you've got the sticker price in cash. In this world, you couldn't even tap into your Visa (NYSE:V) or MasterCard (NYSE:MA) for some down-payment help. How about college -- not exactly a capricious investment in an individual's future earnings power? Sorry, no such thing as Sallie Mae (NYSE:SLM). You're going to have to save up the six-figure expense ahead of time. Operating under such structural constraints, it would take multiple generations to achieve the economic productivity that we currently enjoy on a daily basis.
Conversely, take the United States' recent past, in which lenders granted credit where none in fact had been demonstrated, and borrowed capital was as frequently deployed in one-time consumption as it was invested in future productivity. Times were bubbly for a while, but in the end, savings -- the foundation of capital investment and future growth -- were destroyed by debt-related losses. And unlike factories, machinery, and other physical goods, we can't sell consumption back to the marketplace in order to make good on credit obligations.
Clearly, neither path sustains a healthy growth rate over any length of time.
The current state of credit
Not long ago, Bridgewater Associates released data indicating that household debt service (interest plus principal) as a percentage of disposable income had reached its highest level since the Great Depression. If that's not an argument for consumers to start saving, and for lenders to throttle down, I don't know what is. Over time, repaired balance sheets should naturally yield increased credit transactions. In other words, the economy would lead, and credit would dutifully follow.
But if corporations and households all forsake spending at once, the risks of a deflationary spiral skyrocket. In such a scenario, incomes fall and savings are again destroyed -- this time, not by debt, but by the vacuum exposed by withering revenue.
Credit card issuers seem to be moving us one step closer to this outcome. Shortly after banking sector grim reaper Meredith Whitney warned card issuers not to pull credit lines, reports began surfacing of issuers lowering credit limits to just above, or even below, customers' current balance levels. A recent article cited examples involving GE Money, a division of General Electric (NYSE:GE), and American Express (NYSE:AXP). One wonders how rampant these practices are (or will be).
The problem with these actions is more than an issue of fairness. Axed credit lines have the potential to damage FICO scores, in turn hurting future borrowing ability. What's more, as perceived emergency liquidity vanishes, consumers are likely to take an increasingly defensive posture in their spending.
From this perspective, credit leads the economy deeper into a paranoid funk. Accordingly, it is difficult to see a recovery unless lending practices achieve a middle ground.
Credit & savings: best friends forever?
In past articles, I've been abundantly critical of the government's quixotic and often impractical financial interventions. That said, I do sympathize with the Obama administration's focus on restoring reasonable lending activities. It's no exaggeration to call credit the lifeblood of our economy.
At the same time, I agree that we do need to become a nation of diligent savers. That means actively saving, not just watching asset values swell during bull markets. Furthermore, a more secure financial future will see cash-based emergency funds replace the false reassurance of plastic safety nets.
In the end, if we can stop vilifying all examples of credit and spending, and simultaneously sock away some greenbacks at a sensible pace, we might be able to avoid a bit of needless pain on the path to recovery.
Borrow some of our Foolish thoughts on credit:
