Growing Credit Card Debt Suggests U.S. Consumers Are Close To Capitulating (2024)

Investment thesis: With around two-thirds of the US economy dependent on the consumer, the rate of consumer spending growth tends to be the main determining factor that drives the US economy. There are fiscal as well as monetary policies that can affect consumer spending. For instance, high-interest rates for a prolonged period tend to dampen spending. Government policies such as tax cuts that affect households on a broad scale can also stimulate consumers into higher spending. The most sustainable way to expand consumer spending is for real wage growth to occur. When real wages and other income do not keep up with consumer spending habits, consumers tend to fall back on credit spending.

As we can see, after an initial plunge in credit card debt during the early stages of the COVID crisis, it started to skyrocket sharply, and so far, it shows no sign of slowing down. What this shows is that for the past two years or so, households have been living an unsustainable lifestyle. The sharp slope suggests that the gap between household incomes and spending is now wider than has been in a long time.

Real wage growth has been flat since 2019, and it may be worse than official statistics suggest:

The 2020 spike in wages is an anomaly and it should largely be ignored when it comes to analyzing real wage growth for the past few years. Real weekly wages for full-time employees are currently at the same level as they were in the fourth quarter of 2019.

At first glance, it may not seem like a dramatic situation, but recently we saw a massive decline in full-time jobs, hiding behind an otherwise decent monthly jobs report.

The number of full-time jobs declined by 1.5 million in December, based on the latest jobs report. This deep plunge more or less wiped out all full-time job gains for the year. It also brought the total gains in full-time jobs since 2019 to a very modest 1.2%. In other words, the full-time income of all US workers collectively did not see much gain, while on a per-capita basis, it has been flat.

Real consumer spending has risen by 10% since 2019, while full-time wages have not risen much, on a per capita basis or a collective basis. Part-time job growth has also been flat for the corresponding period, therefore the notion that full-time employees are taking on part-time jobs to cope does not seem to be a collective trend, even though on a personal level, it may indeed be the case for many people. In conclusion, consumers would have to cut their expenditures by about 10% to rebalance their household revenues/outlays, based on the factors covered so far.

It should be noted that real wages are calculated as nominal wage growth, minus official inflation rates. The problem is that official CPI numbers may not always accurately capture how a typical US household may feel inflation affecting them, because the goods that make up the index may not necessarily line up with what typical households spend their money on. Shadowstats has an inflation rate that is consistently higher than official CPI for instance. If this is the case, then real wages may be in decline currently.

In addition to stagnated real incomes, consumers are also facing surging interest on debt costs.

The imbalance between the wage income growth of the consumer collective and the current consumer spending levels, which seems to have grown into a 10% gap since 2019, is by itself serious enough, suggesting that the consumer needs to cut back by as much as $1.5 Trillion/year in spending. When other factors, such as a surge in interest costs on debt are added to it, the picture gets to be far more dramatic.

• Mortgage debt.

In the first nine months of 2023, $1.1 Trillion worth of new mortgages were generated. Annualizing it we can assume that about $1.4 Trillion in mortgages were taken out for the year.

The average interest for mortgages issued in 2023 was 6.8%, versus just under 4% in 2019. This means that relative to 2019, interest on mortgage debt due to the rise in the interest rate amounts to about $40 billion more than it did in 2019. There are also 3 million more mortgages in 2023 outstanding than in 2019. The average mortgage size is about $145,000. Assuming an arbitrary average interest rate of 5% on those extra 3 million mortgages, the total extra interest on mortgages outstanding that consumers have to pay is about $22 billion. So between more mortgages as well as higher interest rates, we are looking at around $62 billion/year in extra mortgage costs that consumers have to pay. This may not be a perfect estimate, but it is perhaps as close as we may get to a realistic point of reference.

• Auto loans.

Auto loan debt increased from about $1.3 Trillion at the end of 2019, to almost $1.6 Trillion. Average interest rates on auto loans increased from under 5% to well over 7% for the corresponding period. It is hard to calculate an exact resulting number in terms of the increase in interest payments as a result of the higher rates between 2019 and the present. We should keep in mind that between then & now there was a period of lower interest rates. Assuming constant rates at the 2019 level, the increase in the volume of debt alone is enough for us to assume that consumers are currently paying at least $20 billion/year more in auto loan interest. Furthermore, assuming that about a quarter of the $1.6 Trillion in auto loans currently outstanding gets converted into higher-interest loans comparatively speaking, we are looking at an increase in interest costs of about $10 billion for 2023, which will be repeated this year.

• Credit card debt.

As the chart I shared earlier shows, credit card debt is currently about $150 billion higher than it was at the end of 2019. Additionally, interest on credit card debt is now about 5 percentage points higher than it was at the end of 2019.

Factoring in higher interest rates and the higher volume of credit card debt, US consumers are now spending about $80 billion more per year to service their credit card debt than they did in 2019.

As we can see, even though credit card debt is only a fraction of the mortgage debt that consumers carry in terms of size, the effect of higher interest rates as well as skyrocketing debt levels can put the squeeze on consumers more immediately. Mortgages are mostly locked into fixed rates, so it is only new mortgages and some of the more exotic pre-existing mortgages that are affected by the higher interest rates. Unfortunately, as consumers are increasingly being squeezed, high-interest credit card debt is the most likely to increase, since it is the most immediately available form of debt that consumers can accumulate as an alternative to cutting back on spending. At this point, the pressure to service debt is arguably creating a vicious cycle, where consumers are just racking up more high-interest credit card debt at an accelerating pace to keep up not just with spending, but also with the pressures of servicing debt.

Monetary & fiscal policies are unlikely to come to the rescue.

There was a recent move in Congress to extend $78 billion in tax cuts from the COVID era. It will provide a boost to households with children through higher CTC refunds, as well as businesses that will pay less in taxes. Given the magnitude of the shortfall between consumer spending and the stagnant real wages, the higher interest burden that I already highlighted, the $78 billion tax break, half of which would go to households, will not make a massive difference in terms of boosting consumer spending. It will also do very little to help families overcome the shortfall between expenditures and income.

Fiscal stimulus has been a go-to policy when the economy slows down since the great depression when Keynesian theory surfaced. The problem is that Keynesian theory also has a second aspect to it, namely an understanding that once an economic downturn ends and growth begins, budget deficits are reduced or even eliminated, to build up the ability to intervene the next time an economic downturn occurs. This has not happened at any point this century. The post-COVID deficits we are seeing are unsustainable.

In the current fiscal year, we may be within range of surpassing the $2 Trillion deficit mark, given a projected deficit of just under $1.9 Trillion, which is already showing early signs of overshooting. The recent passage of the $78 billion tax cut measure will probably ensure that we do see a $2 Trillion + deficit for the current fiscal year. This amounts to about 7% of GDP, which in my view leaves little to no room for further fiscal stimulus.

Monetary easing is what the market is currently banking on. Those expectations led to a rise in the S&P 500 in the fourth quarter of last year of about 14%.

Two weeks into the year, the positive market conviction does not seem to be as prevalent as it was in the fourth quarter of last year. The market is still up nevertheless, suggesting that the market is still betting on the Fed's ability to deliver a significant reduction in interest rates this year.

Recent signs suggest inflation may not yet be fully under control in the US and elsewhere. The latest CPI report came in a bit higher than expected. In the UK, inflation also seems to be more stubbornly persistent than expected, based on recent data. There seem to be some unexpected factors that are pushing inflation higher. Energy prices have been tame, so it is not currently a contributing factor. I am watching energy price developments very closely because an energy price spike would put an end to hopes for lower interest rates, while it would further burden consumers with higher energy bills, which could be the factor that will provide the final nudge for many consumers to capitulate and cut back on their spending.

The latest OPEC monthly report suggests that for the fourth quarter of last year, the total average global production of liquid fuels was about 101 mb/d.

Demand for the fourth quarter of last year averaged 103.2 mb/d. In the fourth quarter of this year, OPEC forecasts demand to increase to 105.3 mb/d. As the chart shows global production is currently flat, not increasing. In other words, unless OPEC has had a massive slip-up in its preliminary data gathering and forecasting, we are currently seeing global liquid fuel stocks being depleted at an average pace of about 2 mb/d. It remains to be seen if this turns out to be the real global liquid fuels supply/demand picture or not. We will likely find out within the next few months, at which point, if OPEC turns out to be right, the news will probably trigger an oil price spike, which will work within the economy and lead to a broad increase in the price of goods & services throughout the economy. That in turn will make it unlikely for the Federal Reserve to deliver on the expected interest rate cuts.

The post-COVID market imbalances as well as the related supply chain & transport disruptions may be gone, but it does not mean that there are no other inflationary factors. For instance, global trade declined by 5% in 2023, with the outlook seen as pessimistic for this year. What this means is that the world is no longer seeing a benefit from increased globalization that seeks to optimize the allocation of resources to deliver goods & services at the best possible price. We are now likely headed into a reversal of the trend, which is likely to be inflationary.

There may be some lowering of interest rates on the way this year, but it may be the case that it will be modest, with modest effects on consumers. It will not be nearly enough to bring household finances back into balance and to stop the current trend of excessive consumer reliance on racking up credit card debt and other easily accessible credit facilities to cover their expenses. There is also a chance that no interest rate cuts will occur this year, depending on several factors that could reignite inflation. It is very likely therefore that at some point this year we will see a capitulation of the US consumer since there is the very real possibility that no fiscal or monetary help of any great consequence will materialize.

Investment implications:

Given the exuberance of the market in Q4 of last year, based on a questionable assumption that interest rates are headed much lower, stock indexes made significant gains last year. Considering the potential risks to the thesis of interest rates going lower, I have been more interested in selling stocks in the past few months than I have been in buying. In particular, I sold AMD (AMD), Intel (INTC), DOW Chemical (DOW), and Chesapeake (CHK) stocks. If I am correct and there will be a major oil price spike in the next few months, I will reduce my holding of Suncor (SU) and CNQ (CNQ) stocks.

The selling of stocks increased my already significant cash position to over 30% of my total investment portfolio. Even though I am currently anticipating a broad stock market selloff, which will provide investors with the opportunity to pick up stocks at a discount, it does not mean that I am not also looking at company-specific or industry-specific opportunities. I have been building a small stock position in emerging Vietnamese EV producer VinFast (VFS), as I pointed out in a recent article. I have also been building up a position in lithium miners, given the steep selloff we saw, I currently Have Albemarle (ALB), SQM (SQM), Lithium Americas (LAC), and Lithium Americas Argentina (LAAC) stocks in my portfolio. I am looking to add to my Albemarle position if it declines by another 20% or so from current levels. I am also considering LAAC for a much smaller increase, relative to Albemarle.

I am on the lookout for opportunities as they arise, even as I intend to save most of my cash in expectation of better opportunities to invest ahead. There are always opportunities within any market conditions. Probably, my large cash position will not seem wise for the first quarter of this year, or perhaps even in the second quarter. If however I am correct and interest rates will not decline as much as the market hopes and oil prices will unexpectedly rise, the already embattled consumers will feel even more squeezed. We will likely see a significant resulting pullback in consumer spending, which will start to show up in the financial reports that will come out by the third or fourth quarters of this year. If this is the case, the fourth quarter of this year could end up being a painful one for investors, especially those who are fully invested. It will turn out to be a great buying opportunity for those sitting in an outsized cash position.

There are of course risks to my thesis. The Federal Reserve may opt to fight against a recession rather than worrying about inflationary pressures and it may lower interest rates even at the risk of allowing inflationary pressures to become self-sustaining. Global oil supply might surprise on the upside, keeping prices low, especially within the current context of lackluster global economic growth that keeps global demand subdued. Even so, the stock market upside potential at the moment seems to be far less than the downside risk. In other words, even if I am stuck in cash for longer than expected, as I wait for that significant pullback in stock prices, it is unlikely that I will miss out on a great upswing in the stock market. Even if I am wrong, I am still 2/3 invested and I am constantly looking for stock-specific or industry-specific opportunities that always arise along the way, regardless of where the broader market is headed, therefore I will not entirely miss out.

My name is Zoltan Ban, I have a BA in economics. I am a personal investor with over a decade and a half of active trading experience.