Last week, pessimists seized on two pieces of bad news about the consumer sector of the economy. On July 8, the Federal Reserve reported that consumer credit, having shrunk 4.4 percent in 2009, fell at an annual rate of 4.5 percent in May. Revolving debt (i.e., credit cards and the like), which shrunk 9.6 percent in 2009, plummeted at a 10.5 percent annual rate in May. The same day, word came that June retail sales were disappointing. A 28-retailer index tracked by Thomson Reuters "shows sales at stores open a year rose only 3.1% in June," the Wall Street Journal reported. "While that compares with a 4.9% drop last year, it wasn't as solid as hoped."
I find it hard to get agitated about this pair of bad-news items. Retail sales are higher than they were a year ago, despite the fact that revolving credit, which fuels such spending, is down significantly. The fact that people are buying more—but doing it with more cash and savings rather than debt—should be regarded as a sign of strength, not weakness.
The revolving debt figures the Fed reports each month are affected by three factors: the volume of write-offs of bad debts, the amount of debt consumers pay back, and the volume of new loans originated. There's no question that there has been a dramatic decline. In May 2010, the amount of revolving credit outstanding was $830.8 billion, down from $928 billion in May 2009 and off 15 percent ($145 billion) from the peak of $976 billion in the third quarter of 2008.
But writing off bad debt has accounted for only a small portion of the decline. According to data the American Banking Association culls from the Federal Deposit Insurance Corp., in 2009 banks wrote off $37.5 billion of credit card balances. Mark Zandi, chief economist at Moody's Economy.com suggests that these charge-offs account for only one-quarter of the decline. ABA chief economist Keith Leggett believes charge-offs—generally done after customers miss three monthly payments—may have reached their peak. The ABA reported on July 7 that delinquencies on bank credit cards plummeted in the first quarter to 3.88 percent—"the first time since the second quarter of 2002 that bank card delinquencies have fallen below 4 percent." (Delinquent payments are those 30 days or more late.) Bank card delinquencies seem to have peaked at 5.01 percent in the second quarter of 2009. "I would suspect from everything I'm hearing that we're going to see charge-offs stabilizing and maybe even modestly improve in the coming quarters, and that's due to the fact that the economy is expanding," said Leggett.
Indeed, the economy has entered its second year of recovery. The seasonally adjusted jobs numbers for the last few years (go here and click "total private") show that in June 2010, 130.47 million Americans had payroll jobs, compared with 130.64 million in June 2009. Unless the next jobs report proves to be a horrendous one, there are likely to be more Americans with payroll jobs today than there were a year ago. That may be one reason people are doing a better job of staying current on their debt and paying it down. Mark Zandi believes about one-quarter of the total decline in revolving loan balances can be chalked up to more rapid repayment. That's good news, too. Debt reduction is a virtuous circle. The Fed's report shows that the interest rate on accounts assessed interest in May 2010 is 14.4 percent. If balances are $100 billion lower than they were a year ago, that's $14.4 billion per year less that Americans spend on credit card interest—and $14.4 billion more that they have to spend on bills and at the mall.
With charge-offs and consumers paying down debt more rapidly each accounting for 25 percent of the total reduction in revolving credit, Zandi believes that higher lending standards and lower demand by consumers account for the rest of the decline. All of which is to say that falling credit card balances and higher credit standards can coincide with more shopping. In fact, retail spending has been rising sharply even as revolving credit has fallen. The Census Bureau's report on May retail sales shows sales were up 6.9 percent from May 2009 (not adjusted for price changes), and that "total sales for the March through May 2010 period were up 8.1 percent from the same period a year ago." In other words, the consumer economy today needs significantly less high-interest revolving credit in the system to produce a dollar of sales than it did a year ago. To a degree, American borrowers and lenders are taking the advice of deficit scolds, personal finance advisers, and critics of the banking system. The banking system, which destroyed itself through the heedless extension of credit, is thinking twice before putting money out on the street. Shoppers may not be cutting up their credit cards, but they're using them less frequently, paying down balances more rapidly, and doing a better job of staying current. Meanwhile, they're increasing spending at a rate far above the rate of inflation. Remind me again where the bad news is.