By Ryan McMaken*
As interest rates rise on everything from mortgages to car loans to government bonds, it also means interest rates on credit card debt rise. That’s not exactly good news, as so many indicators are pointing to a recession – and the accompanying deterioration in jobs – on the horizon. Many Americans could soon find themselves in a situation with more debt at higher interest rates while real wages fall.
Earlier this month, Bankrate.com reported that the average credit card interest rate rose to 19.04%. That’s a 30-year high and the highest rate since 1991, when the rate hit 19%. That can mean real financial woes for ordinary households, but that’s exactly what we should expect following this year’s Federal Reserve policy change, which finally sees interest rates drift higher after more than a decade of quantitative easing and ultra-low interest rate policies. Last year, the Fed raised its target interest rate from 4.0% to 0.25%.
NBC reports how this affects credit card debt:
The increase in the federal funds rate boosts the so-called base rate. This is the interest rate that banks charge their most creditworthy customers. It is currently 7%. The final APR for a credit card is determined by the prime rate plus a bank’s margin for lending to a given customer.
The new average is a significant increase from the 16.3% average credit card rate earlier in the year. According to Bankrate, if you have $5,000 in credit on a credit card — which is the current national average — the minimum monthly payment at that rate would cost $5,517 in interest over 185 months, or about 15 years. At today’s interest rate of 19.04%, you would pay $6,546.
The Fed report also reported, “Strength in credit card demand and access coincided with record growth in credit card balances over the past year.” up $38 billion since the second quarter, a 15% year-over-year increase was the largest increase in more than 20 years.”
Consumers also appear to be expecting to spend more on credit cards in the near future as many seek even more consumer credit. Americans are seeking less new mortgage and auto debt but are still turning to credit cards, according to a new report released Monday by the New York Federal Reserve:
The credit card application rate remained resilient in 2022, reaching 27.1% in October 2022, ahead of its October 2021 level of 26.5% and its pre-pandemic level of 26.3% in February 2020. The average application rate for credit cards in 2022 overall was 26.7%, 3.6 percentage points more than the 2021 average.
Do we need to worry about this? Fed economists would tell you no on the assumption that Americans supposedly have a vast stash of savings that they can use to avoid defaults or pay off debt. However, this easy-going stance on rising debt seems less justified by the day. As the labor market weakens, real wages fall and interest rates rise, rising debt cannot be averted so easily.
A free cash boost followed by declining austerity rates
Finally, in 2021, consumers were actually using their stimulus checks to pay down credit card debt. They saved more than they had in decades. As the Fed continued to push interest rates lower, consumers refinanced home loans into even cheaper loans. But as the recent surge in credit card debt shows, those days are over. Moreover, now that stimulus checks have dried up, the savings rate has fallen to its lowest level since 2008.
The savings stock does not seem to be completely used up yet, but we are already on the right way there. Some analysts estimate that consumers still have about nine to twelve months in this savings cushion.
However, this may prove optimistic depending on at least three factors: if real wages continue to fall, if job losses increase rapidly, and if interest rates continue to rise.
Falling wages, job losses and rising interest rates
First, there is the problem of real wages. As we have seen, price inflation is outstripping wage growth, and that means that real wages for ordinary Americans (on average) have fallen for nineteen straight months. That won’t exactly help expand workers’ savings.
Secondly, one can no longer speak of a macroeconomic labor shortage. Sure, there still seem to be labor shortages in retail and hospitality, but real estate and tech don’t seem to be doing so well. Rather, each week now brings multiple announcements of new layoffs from tech companies and from real estate/construction companies. After tens of thousands of layoffs announced by Facebook, Amazon and Twitter in recent weeks, Google announced 10,000 layoffs today and Fidelity National Information Services announced thousands more. Real estate sales platform Redfin recently shut down its home flip business, shedding more than 800 employees.
From real estate to tech to crypto, we can expect more layoffs and losses as easy money grows scarcer.
Finally, there is the question of rising interest rates, which will not only result in job losses across the economy, but will also accelerate the burden of new credit card debt on consumers. This will lead to increasing arrears and tightening budgets overall. Some observers have suggested that credit card debt isn’t a big deal right now, as total credit card debt — even with the current increase from last year’s totals — isn’t significantly above the longer-term trend. That would be pretty compelling if that mounting debt didn’t also come with one of the fastest rises in interest rates in decades. Thanks to the Fed being so behind the curve on price inflation, we are in the midst of the fastest cycle of rising interest rates since at least the 1980s. But over the past 40 years, rising debt has been accompanied by a sustained decline in interest costs. Now that process is reversed and interest rates have quickly returned to 2007 levels. If the current upward trend in interest rates continues, this could lead to a significant increase in the burden of consumer debt on households.
All of this would, of course, be made worse by a further slide into recessionary territory. Leading up to this month’s election, both the Fed and the government have repeatedly denied that a recession is imminent or is already here. This is despite two quarters of declining economic growth, which economists commonly refer to as a recession. But even if the first half of 2022 isn’t called a recession, the data now strongly points to a 2023 recession. The yield curve has inverted, global trade is weakening, advertisers are retreating and house prices are slipping towards decline.
recession almost guaranteed
In fact, even some Fed economists are beginning to concede that now that the election is safely over, a recession is on the horizon. Eric Rosengren admitted earlier this month that a recession is likely, although he was cautious about calling it a “mild” recession. This is of great importance as the role of Fed economists is to generally be a cheerleader and never talk about recessions until they are undeniable. After all, then-Fed Chairman Ben Bernanke denied that a recession was in the offing as late as the first quarter of 2008. That was months after the recession had already started. The Fed always downplays the risk of secession, so it’s remarkable when Rosengren admits any Some kind of recession is likely. The government now admits that the boom days are over, but now insists that a soft landing is possible and all that will happen is a slowdown in economic growth.
But for all the positive words, Americans are piling on more debt as real wages fall, job losses mount and the cost of debt rises. In all of this, we can thank Federal Reserve economists and technocrats for years of bad investments and an economy of zombie corporations and fragile household budgets built on shaky foundations of easy money and mounting debt. It didn’t have to be this way, but the regime is addicted to easy money and the Fed is more than happy to accommodate. Now we have to deal with the inevitable bankruptcy that comes after the artificial and unnecessary inflationary boom.
*About the Author: Ryan McMaken (@ryanmcmaken) is Senior Editor at the Mises Institute. Send him your article submissions for the Mises wire and power and market, but read the item policies first. Ryan holds a bachelor’s degree in economics and a master’s degree in public policy and international relations from the University of Colorado. He was a real estate economist for the state of Colorado. He is the author of Commie Cowboys: The Bourgeoisie and the Nation-State in the Western Genre.
Source: This article was published by the MISES Institute