The Psychology of Credit and Debt

As men move, so do markets. The public’s willingness to “submit to the servitude of credit” is at an all-time high…and it does not bode well for the U.S. economy.


It’s hard to shock people with numbers these days, especially when it comes to debt – so many folks have so much of it. An eight, nine, or ten-digit figure just doesn’t impress…unless it relates, somehow, to “what will happen to me.”

So let’s assume that you already know there’s “a lot of debt out there,” and that you want to get right to the “me” part. Some patience, please; the “me” part is clear only in the context of “us”…us being the mass psychology that actually created the epic debt bubble.

Consider, therefore, a few facts about “us” –

* Americans paid out approximately $63 billion dollars in credit card interest alone in the year 2000.

* Undergraduate college students carry an average of three credits cards which total an average balance of over $2,000, reports the Louisiana State University’s study of Youth Financial Literacy Statistics.

* According to the same study, academic administrators say they lose more students to credit card debt than to academic failure.

* The “late fees” charged by credit card companies have become the industry’s fastest-growing revenue source, rocketing from $1.7 billion in 1996 to $7.3 billion in 2002.

The Psychology of Debt: Minimum Balance

* Senator John Edwards claims that, “Almost half of all Americans pay the minimum [credit card] balance or less each month, running up large interest debts.”
* The outstanding U.S. Public Debt as of August 18, 2003 was $6,776,165,078,368.71. The total working population of the U.S. is approximately 217,000,000. So if each hard- working American contributed their due, each of them would owe $31,226.58.

* Then there’s real estate. During the most aggressive interest rate-cutting campaign in its history, the Federal Reserve has helped millions of households convert their assets into debts. But this debt will produce no income, only the burden of repayments.

Yet the Fed’s policy has not increased overall borrowing by businesses (despite the lowest lending rates since the 1950s), which could use the loans to create growth. So the Fed’s attempt to expand credit has increased “bad” debt, even as “good” debt shrinks. This (among other things) is what the media somehow overlooked in the frenzy of “Fed rate cut” stories over the past three years.

Millions of families use their homes as a checkbook, via home equity loans and credit lines. In revolving home equity loans, for example, the debt has grown from $128.3 billion in January 2001, to an all-time record $243.4 billion as of June 2003. As a percentage of market value, home equity has fallen to the lowest level since the Fed began keeping records in 1965.

And what will happen when the interest rates, which are not fixed at recent lows, start their inevitable rise? Many people may find it difficult to make increasingly large payments, especially if the unemployment level doesn’t begin to drop.

The Psychology of Debt: Why So Much?

The obvious solution to making larger payments would be to use savings. But, the savings rate of the average American household has dropped by two-thirds since 1989.

Why do we have so much debt and so little savings?
Because we are a nation of consumers who live beyond our means. Our consumption exceeds what we can afford…hence the overuse of credit, and the debt extremes that come with it. The Federal Government has encouraged credit expansion, keeping interest rates low to facilitate the use of credit. Multiple sources of credit used to be the province of the rich, but now they’re a rite of passage, a necessary step on the way to adulthood. You need a “credit record” to open a bank account, to get a loan, to buy a car or a house, to rent an apartment or even to get a job. And you want it for the sheer convenience it provides:
Pay at the pump. Shop on-line. Get 10% off your first purchase when you get an in-store credit card. Get a second mortgage with no appraisal fee. Put no money down and get two years interest free! Apply today and get a great fixed rate! American Express: Don’t leave home without it. Visa: everywhere you want to be. Earn cash back each time you use your Discover card.
These are more than tag lines from advertisers. The public’s willingness to submit to the servitude of credit is a direct measure of their optimism – or pessimism – about the future, and a reflection of mass psychology and social mood.
The psychology of debt has a context – a broad pattern of behavior that produces very visible extremes: the stock market bubble, the real estate bubble, and yes, an immense debt bubble.

The Psychology of Debt: From Optimism to Pessimism

A pattern this large doesn’t change overnight, but there’s no doubt that a reversal from optimism to pessimism is underway. This is why the stock market peaked in early 2000, and why so many rallies since then have failed (the current rise notwithstanding). The reversals in the real estate and debt bubbles will be just as swift and sudden, and every bit as unexpected.
“Once you understand the fundamentality of social mood change, you approach the socionomic insight,” writes Robert Prechter in the foreword to his book, Pioneering Studies in Socionomics. “Conventional assumptions about the direction of social causality are not only incorrect but opposite to what occurs. Social events do not compel social mood, as is widely supposed; rather, the patterns of social mood impel social events. For example, the state of the economy does not underlie social mood; social mood underlies the state of the economy.”
Understanding how “cause and effect” really work in social trends equips you to anticipate and identify stock market trends. You can’t be on the right side of a trend you don’t recognize – which is the plight of most investors, and of most households that carry too much debt.
The danger will only grow in the months ahead…yet – for individuals who understand the trend – so will the size of the opportunities.


Wendy Raffel and Robert Folsom
for The Daily Reckoning

November 13, 2003

Wendy Raffel is a financial writer for Elliott Wave International, providers of world-class global market analysis since 1979, as well as a socionomist at The Socionomics Institute. With a background in public broadcasting, Wendy continues to produce radio pieces independently.

Robert Folsom is also an EWI financial writer and editor. He has covered politics, popular culture, economics and the financial markets for 16 years, and today writes EWI’s popular Market Watch column. Robert earned his degree in political science from Columbia University in 1985.

Stocks go up…and gold goes up, too. Stocks go down…and gold goes up anyway. Gold keeps going up…rising $6.80 yesterday to close way over $390.

It passed our buying target of $350. Then, it rose above our second buying target of $370. Now it looks as though it will break through our third buying target – $400 – even before we set it. We feel like a kid again…trying to grab a bar of soap in the bathtub; it slips away each time.

No, it’s not easy, dear reader. There is so much ‘noise’ to filter out: buy this stock, buy that stock…corporate earnings…corporate scandals…stocks up…down…Fed rumors…terrorist attacks…sentiment indicators…blabbermouths on TV…empty heads on the editorial pages…

But gold also rises.

We are at the beginnings of what we believe will be a major bull market in gold – one that will last for several years and take gold’s price above $1,000 per ounce. Of course, God does not whisper His plans in our ear…nor do we have any way of reading the news before it happens. It is not given to man to know the future. Besides, if we really knew what the price of gold would do, we wouldn’t waste our time telling you. At least, not for free!

No, our view of gold is merely a default position; we just don’t know what else to say.

Over the last 32 years – since the collapse of the Bretton Woods semi-Gold Standard system – the world has been drenched with U.S. dollars. Not since the time of Noah has mankind seen such a flood. Since the arrival of Alan Greenspan at the helm of the Fed, more U.S. dollars have been created than under all the Fed chiefs and all the Treasury secretaries in the history of the Republic. The money sloshed around the globe…watering economies and greening investments almost everywhere.

Americans have had a credit card with no limit. If they ran out of money to spend…they could just print more.

After WWII, America was the world’s biggest creditor…more people owed more money to Americans than to any other people. By 1988, their position had weakened…but they were still even with the world. But now, they’re nearly $3 trillion in debt to the rest of the world…and the debts increase (as measured by the current account deficit) at the rate of $1 million per minute.

In an 18-month period, the federal government alone went from surplus to deficit – a swing equal to half the total of all the gold ever mined in all of history. Next year, it is expected to borrow almost as much.

Former Treasury Secretary Paul O’Neill wanted to know just how deep the Federal government’s hole really was. Putting a team of economists on the case, he discovered that foreseeable obligations exceeded expected receipts by $44 trillion – or about 30 times the world’s gold supply.

Meanwhile, in the private sector, total debt now equals about 20 times the world’s gold. By every measure we know, Americans have never before carried such a load of debt…and the world has never before had so little gold, by comparison, to balance against it.

We can’t remember how we made the calculation, but when we compared the increase in the number of dollars to the increase in the gold supply, we discovered that more than $6,000 came into being for every new ounce of gold pulled from the earth.

People believe the ‘recovery’ is a done deal. But a recovery from what? The recession was a flop – people never cut back spending. In an effort to get the economy moving, the Fed turned on the hoses, showering consumers with more credit, more dollars…and drenching them even further in debt. But where are the jobs? Where is the capital investment? How come the lines of people in bankruptcy court are longer than ever? Why are foreclosures at an all- time peak?

Inasmuch as we can’t know the future, anything is possible. Interest rates may go up…or they may go down. Stocks may become even more overpriced. Inflation? Deflation? Who knows? All we know is that, for the moment, gold also rises. And we see nothing likely to stop it. It will have its day, no matter what.

We turn to Eric for more news…


Eric Fry writing, very early, from New York…

– Strange day on Wall Street…stocks soared, while the dollar tumbled…and gold rocketed to a new 7-year high. The phrases “dollar sell-off” and “stock rally” do not normally appear side by side. But in the Greenspan economy, anything is possible; the economy can boom while jobs disappear, GDP can jump 7.2% while national indebtedness soars, and the stock market can rally while the dollar’s value plummets.

– Yesterday, while the dollar’s value plummeted 1% against the euro, the Dow rallied 111 points to 9,848 and the Nasdaq jumped 42 points to 1,973. We are not persuaded that a depreciating dollar is bullish for anything other than gold, the ultimate counter-currency. Yesterday, gold jumped $6.80 to $395 an ounce, its highest price since May 1996.

– The dollar’s distress does not deserve all of the credit for the gold market’s strength. Escalating violence in the Middle East warrants at least a dishonorable mention. “Certainly the gold market is taking notice of the Middle East,” writes John Myers, editor of Outstanding Investments. “As the situation in the Middle East goes from terrible to terminal, you will see higher gold prices, perhaps a lot higher.”

– Of course, most gold stocks have been in “rally mode” for months already. Gold stock investors tend to recognize macro-economic and geo-political crises well before their tech-stock buying counterparts. Indeed, gold stock investors tend to recognize crises, even when none exist.

– The gold market’s months-long rally implies that global macroeconomic and geopolitical stresses are mounting. Yet, the Nasdaq’s months-long rally implies that everything is just hunky-dory…Or does it? Maybe the Nasdaq’s rally implies nothing more than the fact that speculative trading has made a comeback. To illustrate, let’s indulge in a malicious little comparison between the shares of Newmont Mining and those of CMGI, one of the infamous “Internet incubators” of the late 1990s.

– According to Bloomberg, “CMGI Inc. owns and invests in business-to-business and business-to-consumer Internet companies. The company offers products and services for interactive advertising and marketing, as well electronic commerce products and services to consumers and businesses.” We don’t really know what this description means, and we suspect that most of the company’s shareholders don’t, either.

– But whatever it is that CMGI does, it does it unprofitably. Since the end of 1999, this formerly hip, B2B and B2C e-commerce company has racked up an astounding $7 billion of losses on sales of less than $3 billion…and it is still losing money. Nevermind the losses, CMGI was precisely the sort of stock that investors wanted to own during the late 1990s. Amidst the Internet-stock mania, CMGI shares skyrocketed from $5 a share to more than $160…and then crashed.

– CMGI was hardly unique. Many high-flying tech and Internet stocks reached their zenith in 1999 and 2000. In those days, almost every four-letter symbol on the Nasdaq seemed to represent a multi-billion dollar company producing multi-billion dollar losses. But 2000 was also the year that the gold share bull market began. Since late 2000, Newmont Mining shares have tripled, while CMGI shares have collapsed more than 90%.

– Why do we reminisce? Because investors are buying speculative stocks again, and doing so with only slightly less abandon than they displayed in 2000. Over the last 12 months, Newmont shares have posted a healthy 80% gain, while CMGI shares have soared a freakish 500%. The stock now boasts a market capitalization of more than $800 million. Maybe this former penny stock is worth every penny of its hefty market cap…Maybe not. Either way, the history of financial markets suggests that money-losing penny stocks tend to jump 500% when rallies are ending, not when they are beginning.

– Speculation isn’t a bad thing…as long as you remember to pull some chips off the table.


Bill Bonner, back in Paris…

*** Does a credit-driven consumer economy really work? Or have Americans merely worked harder in order to make up for a bad system? We answer the questions as well as pose them: almost all the income gains of average Americans – since the advent of the Dollar Standard System – have come from longer working hours. Over the past 30 years, middle-income couples have added an average of 20 weeks of work to their annual schedules, equal to 5 additional months of labor. Inference: the consumer economy is a fraud. (More from our friends at Elliott Wave, below…)

*** No doubt about it, the Fed has managed to create a real boom – in China! The Chinese are buying up resources at an astounding pace, in order to feed their booming industrial machinery. Shipping rates have doubled in the last 3 months. Steel is up. Copper hit a 6-year high. Aluminum has doubled.

While commodity prices are going up, real labor rates worldwide may be in a major deflationary trend. A Chinaman will work all day long for just $5. Hard to compete with that.

*** “You don’t understand,” began the explanation. “Henry’s class is the only class in the world to get to do their ‘profession of faith’ in the Vatican. It takes place at Easter. This is a big deal. And they take these things very seriously. They know Henry was not baptized Catholic; they have his birth certificate in his file. So, I just want to talk to them to make sure he is not excluded from the activities.”

*** “Thank you so much for the ‘George W. Bush, U.S. President & Naval Aviator’ action doll. I haven’t been able to put it down since I opened the box!…It’s funny; George W., the doll, is ‘fully articulated,’ but George W., the human is completely inarticulate.”

Eric Fry was thanking a reader for sending us two dolls – vaguely resembling the Commander in Chief in full military regalia, as he appeared on the deck of the Abraham Lincoln. We noted that the doll was made in communist China…

Curiously, the leader of the free world is saluting with the wrong hand, but what do the Chinese know?

*** And here’s an interesting note from Ann Coulter:

“The U.S. military has had considerably more success in turning Iraq around than liberals have had in turning the ghettos around with their 40-year ‘War on Poverty.’ So far, fewer troops have been killed by hostile fire since the end of major combat in Iraq than civilians were murdered in Washington, D.C., last year (239 deaths in Iraq compared to 262 murders in D.C.). How many years has it been since we declared the end of major U.S. combat operations against Marion Barry’s regime? How long before we just give up and pull out of that hellish quagmire known as Washington, D.C.?”

*** Columnist Tom Friedman, always a source of laughs, believes the U.S. is doing important work in Iraq. “Nation building,” he calls it. He seems to believe the U.S. military can build a model society – to his specifications – in a country thousands of miles away populated by hostile desert tribes, where he doesn’t speak the language, understand the local culture, the history, or the local cuisine…and where a man can’t even get a decent drink. We wish him well. If he succeeds, he can launch an attack on Washington next.

The Daily Reckoning