Our Economic Crisis is Debt - Part 2

I have finally seen someone on the national TV programs that told the truth about the economic free fall we have been experiencing in our economy. Chuck Colson, the head of Prison Fellowship Ministries appeared on the Fox News Channel on the weekend of February 28th. Mr. Colson, in his interview stated that it was greed on the part of all Americans which was the root cause of our economic woes. According to Mr. Colson, this greed has been manifested in our pervasive misuse of credit for instant gratification and the overturning of the Biblical values of hard work, saving, and delayed gratification.


Let's examine the mechanics of Mr. Colson's statement. Over the past 20 to 30 years, there has been an incredible, and reckless, extension of credit to every man, woman, child ... and even pets. It is not uncommon for a family's mailbox to receive multiple applications for credit cards on a weekly basis, irregardless of the credit worthiness of the solicited individual. The over availability of credit has led to Americans purchasing goods and services before they can actually pay for the purchased items. Think about this a moment ... buying a dress on credit before you can actually pay for it does not create a "new" demand for a dress ... it actually moves a future demand into the present time. This is critical to understand. Credit does not create new demand, it simply shifts the timing of the demand.


Look at the effect this has had to our economy. Through the use of credit, artificial demand has been created in the present. Businesses see this faux demand as an increase, which causes businesses to expand, thinking this fax demand actually points to a larger demand in the future. Businesses expand, create new jobs, buy more raw materials because of a false projection of demand. Now, at some point, the limit of credit is reached. What happens when the people who are buying goods and services on credit have no more credit? The demand falls off precipitously! Shades of 4th quarter 2008. And all that planning and investment for the projected future increase in demand is in reality an over building of production. This overbuilding actually slingshots the economy into a decline. And until the debt is paid down, there can not be any significant return to normal demand patterns.


Now, I know that an intelligent one or two of you will take exception to my statement that loose credit does not create increased demand. I will probably be told that by giving credit to people who could not afford to buy something, creates a new demand for the good or service they purchase with credit. I will concede that there may be a small increase in demand from this factor, but I would point out that this increase can only occur when someone purchases a good or service on credit that they would not have purchased without the credit. Further, I will suggest that this limited increase in demand is more than offset by the loss in demand that comes from making interest payments.


Let's examine what happens here. If I make $1000 per month in take home pay. I could purchase up to $12,000 in goods and services in a year's time. Lets assume, however, that I Use $1000 of credit at the start of the year to purchase an item. An interest rate of 25% is no longer uncommon. This means that of my $12,000 take home that I could spend in a year's time is reduced by $250, making my purchasing power now $11,750. Well, in today's economy, we have many people whose credit exceeds their annual purchasing capabilities. In this example, if I have borrowed $12,000 at a 25% interest rate, my purchasing power is eroded to only $9,000. So, you can see that using credit actually reduces purchasing power which translates into decreased demand for goods and services.