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Recovery should not be defined as moving backward to the way the economy used to be structured. That was a bubble, built primarily on cheap credit and not long-term investments.
Moreover, much of the recent borrowing increases have been in revolving credit, primarily credit card debt, in order to meet basic needs. That is not the kind of consumption that will generate a recovery, especially since the costs of credit card debt are high and will weigh back down on household balance sheets in the months and years to come. A recovery built solely on expanding consumer credit and mortgage credit is simply another bubble and unstable economic foundation.
America had started the process of household balance sheet deleveraging after the bubble burst. Mortgage debt levels have fallen sharply. And consumer credit—all debt other than mortgage debt—was declining as well. But in the summer of 2010, as the post-recession faux-recovery created false hope that the good times were back and as savings decimated by the bursting bubble began to hit zero in the midst of a weak economy, consumer credit levels (led by credit card purchases) began to rise again.
The figure below shows that consumer credit fell 7.1 percent from June 2008 to June 2010, but since then has grown 6.9 percent to June 2012 (according to data released this month by the Fed).
The rising aggregate consumer credit level means that household balance sheets are not shedding debt like they need to in order to contribute substantively to economic growth. Unless this changes, we’re pretty much screwed.
High household debt means less economic and labor mobility. Families cannot move to better employment if they are stuck in a house they cannot sell or have credit card bills crushing their credit score and making it harder to move. Private sector debt also means fewer family vacations, no upgrades on household appliances, and less investment.
Perhaps most damning is that households deep in debt mean downward pressure on entrepreneurial expansion. Many small businesses are family run, or are financed from household balance sheets. As long as entrepreneurism is stagnant, the U.S. economy is not going to see real growth.
Rather than public policy seeking to make borrowing cheaper, American leaders need to allow for household balance sheets to deleverage. That will mean short-term economic pain in exchange for a more robust economic growth period on the other side. And since the economy is in stall mode currently, the directly-associated pain will be muted anyway. Both President Barack Obama and his Republican opponent Mitt Romney are kidding themselves if they think they can inspire a recovery in the next several years without consumer credit levels falling and household debt levels coming down.