The Great American Deleveraging, Chapter 2

The great deleveraging has entered a new chapter. We Americans shed $21.6 billion worth of personal debt in July, excluding mortgages, the Fed quietly announced yesterday. That’s the largest monthly deleveraging (measured in dollars) in American history.

Factor in the last 12 months or so, and the trend is clear: Not only are Americans getting rid of debt, but they are doing so at an accelerating rate.

Consumer Credit Contraction

In other terms, July’s decline marked a 10.3% annualized rate of debt dumping, the biggest since 1975.

We’re proud of the Average Joe… like any addiction, weaning off easy money isn’t easy. We’ve had to do it ourselves, personally and professionally, and it’s not exactly fun.

But we suspect this is lousy news for banks and retailers. As we’ve forecast numerous times in these pages, most creditors are currently drumming up plans for the recovery — not bracing for a long slog of continued credit deleveraging and default. Here’s one example: Wall Street expected a consumer credit contraction of $4 billion in July. Off by more than a factor of five, it’s safe to say the men behind the curtain are just a bit out of touch.

And we hasten to add July’s record deleveraging included a healthy chunk of the “cash for clunkers” program. You know… that “stimulus” where the government gave you $4,500 to get rid of your working car in exchange for a new car and $15,000 of debt.

How much further could this credit contraction go? Heh, here’s the above chart, zoomed out a couple decades:

Outstanding Consumer Credit

“The U.S. financial system is still in the early stages of working through an enormous balance sheet problem,” says Dan Amoss. “Banks and other financial intermediaries lent trillions of dollars to borrowers under mistaken assumptions about the future. Credit losses must be recognized and absorbed…

“Lending loosely to borrowers under mistaken assumptions about the future, or more simply a ‘credit bubble,’ is very destructive to any economy. It feels great on the way up, but always ends in tears. Entrepreneurs make capital investments and hiring plans in order to fulfill this illusion of sustainable demand — the temporary demand that comes from those who borrowed against tomorrow’s income to boost today’s consumption. Even worse, those whose jobs depended on the credit bubble borrowed against their future income — which is now gone, or much lower — to spend or overpay for a house. It all adds up to what could be the scariest cycle of credit losses in history.”

The Daily Reckoning