Credit Card Cancer

This week, with his pronouncement that “credit is the lifeblood of a healthy economy,” President Obama reiterated what has been one of his most common themes in diagnosing our economic problem. The president has relied on this bedrock belief to propose policies that place the restoration of credit as the highest priority. However, despite his seemingly earnest intentions, the president and his economic advisors have misdiagnosed the ailment. Savings, not credit, is the lifeblood of a healthy economy. When not used properly credit can be like a cancer that sickens an otherwise healthy economy.

What everyone seems to have forgotten at this point is that credit does not come from thin air. Even in a system in which bank reserves are leveraged many times, someone has to put savings in a bank for the bank to turn around and make a loan. As a result, the bedrock is the savings, which allows for the credit to flow. Credit extended without adequate savings inevitably leads an economy into disaster.

The primary mechanism that has injected credit where it does not belong is the massive credit card industry that has developed in the United States over the last generation. The ease with which these cards may be obtained and the degree to which Americans now rely on them for routine purchases has created a culture of credit that simply has no precedent in a healthy economy. Until this culture has been reformed, America’s fight to restore economic vitality will be a lost cause.

However, this week a much discussed opinion piece in the Wall Street Journal by top banking analyst Meredith Whitney, indicated that many Americans besides the president are still looking toward credit as the means of economic salvation. In her piece, Ms. Whitney writes,

“…Undeniably, consumers look at their unused credit balances as a “what if” reserve. “What if” my kid needs braces? “What if” my dog gets sick? “What if” I lose one of my jobs? This unused credit portion has grown to be relied on as a source of liquidity and a liquidity management tool for many U.S. consumers. If credit is taken away from what otherwise is an able borrower, that borrower’s financial position weakens considerably. With two-thirds of the U.S. economy dependent upon consumer spending, we should tread carefully and act collectively.”

In order to keep the economy functioning, Ms. Whitney asks the credit card providers and the federal government to keep credit lines open, so that millions of Americans can keep on spending. However, while such actions would certainly keep our phony economy propped up a while longer, it would further weaken the very foundation upon which a real economy will eventually have to be rebuilt.

Without a doubt, Americans, and all other people for that matter, benefit from having access to “rainy day money.” But Americans should be saving for a rainy day, not adopting the attitude that if it rains I’ll whip out my credit card. If Americans need to pay for a suddenly ill dog, to straighten their kid’s teeth, or to pull them through a period of unemployment, they should save some of their present earnings.

But saving money requires a reduction in spending, and that is something that modern economists, within and without the Administration, cannot abide. A drop in spending will create a sharper contraction in our economy – which is now comprised of 70% consumer spending. But this is no reason to discourage the process. The option to go into debt in the event of an emergency is no substitute for building personal savings for such events. Not only does such a strategy jeopardize the solvency of individuals or families when they are at their most vulnerable, but it deprives society of badly needed savings.

Currently, with so many financially strapped Americans looking to draw on their credit lines, the fallacy of this ‘savings substitute’ is easily revealed. With lenders’ capital depleted, and falling home prices, and rising unemployment putting borrowers at greater risk of default, credit is naturally harder to come by. Had only a small percentage of borrowers needed to access their credit card “rainy day funds” there would have been no credit crisis. But with a deluge drenching so many at once, there was simply not enough credit umbrellas to go around. Had Americans actually been saving money instead, everyone would have his own umbrella and would not now be looking to borrow someone else’s.

Most importantly, as savers bank their earnings into “rainy day funds,” in addition to earning interest, those savings are available to businesses to make capital investments, produce goods and services, and provide employment. Without access to those savings, such investments cannot be made, and society is worse off as a result.

Lastly, savings can always be relied upon whereas credit is ephemeral. Remarks this week from the Chinese premier Wen Jiabao should serve notice to all Americans that the day will soon come when the Chinese stop lending us their umbrellas. When that happens, the average American will be soaked to the bone.

For a more in depth analysis of our financial problems and the inherent dangers they pose for the U.S. economy and U.S. dollar, read my newest book “The Little Book of Bull Moves in Bear Markets.” Click here to order your copy now.

For a look back at how I predicted our current problems read my 2007 bestseller “Crash Proof: How to Profit from the Coming Economic Collapse.” Click here to order a copy today.

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3 Responses to "Credit Card Cancer"

  1. A.W.Bost   March 14, 2009 at 11:18 pm

    There IS A Pill To This Kind Of Depression.Everything has become too redundant in today’s society. You see the big difference between now and the great depression is technology. If this resilient economy continues down this death spiral path we are currently on then there will only be limited opportunities and only a small limited amount of time before the real wars erupt. We need to flip this country on its head. We desperately need something radical. I have been thinking about this and the only solution is a GIANT RESET BUTTON which literally releases everyone. Just move, allow every family to move. There are a lot of vacant homes out there and if we give these families, that are willing to take the risk, time from creditors (6-9 months) in order to settle down, readjust and find NEW jobs. The main change would be a jolt of passion to physically start a new life. If done big enough, around the entire U.S.A, I believe people will be inspired to work harder and live better lives. The goal is to create a new physical life which would in turn completely change the attitudes of the people, which should be our # 1 priority. We are a country that loves working and loves spending, there is absolutely nothing wrong with that. This is one of the most exciting times in all of our lives, as far as new tech goes. Desiring an object and creating a goal that induces incentive is great. This is the main reason our country is so liquid. The main goal of my plan is to create an ENORMOUS DEMAND FOR TRADE instantly, everywhere. China loves it and we provide a global trading hub for the rest of the world. Give $15,000 to every family, with no option to exchange for other currencies, which is willing to do this. If everyone moves there will instantly be a HUGE demand as well as a HUGE supply for and of people across this great nation of ours. This then in turn ignites the spark of the ultimate goal. Specialization would come back into the picture and GDP can continue to explode on its path to the upside. The main rule is to keep everything completely fair across the board. One problem that would arise is what to do with the current mortgages. The toxic credit of the families would be extended by the government, as well as payment history and different unilateral credit scores transferred and protected by them as well. It sounds completely crazy but I believe we need to reawaken the spirits of our fellow Americans. There is still time to turn things around but we need to remember the clock never stops ticking and we can’t stop bigger snowballs once they start. It is critical we hit the button.

    • Guest   March 17, 2009 at 5:40 pm

      I completely agree with one point.It really does sound “completely crazy”.

  2. Anonymous   March 20, 2009 at 2:43 am

    Schiff has it right again. Savings,savings, savings.