Many Americans Paying Down Their Debt

When the economy is strong, consumers tend to spend freely, save less, and rack up credit card and other debt without a second thought. When economic uncertainty sets in, however, the reverse is true—spending comes to a screeching halt and consumers begin repaying debt diligently. In fact, in July of 2009, Americans repaid $21.6 billion of credit card and other debt. This represents the biggest drop in consumer debt since 1943, which is the first year the Fed began keeping track. July’s figures translate into an annual debt repayment rate of 10.3 percent. Additionally, compared to last year, outstanding consumer debt has dropped by 4.2 percent. If this trend continues, it could permanently alter the U.S. economy.

Uncertainty Begets Frugality

Economic uncertainty inevitably elicits newfound thrift in consumers, who become more fiscally conservative the less secure they feel about their future. Rampant unemployment and devastating losses in the real estate and stock markets have taken a toll on Americans’ optimism about the future. When this happens, consumers begin bracing for the worst by reining in spending, building up savings, and paying down credit card debt and other loans. In other words, an economic scare has the ability to fundamentally change the way consumers feel about spending money they don’t actually have.

Economic Consequences

Because 70 percent of the U.S. economy is consumption, economists are disheartened by the news that many Americans are saving more and paying off their debt. In other words, thrift, although an admirable virtue for individuals, is generally bad for the economy, particularly when consumer spending is critical to a healthy economic recovery. Generally speaking, saving, reducing spending, and repaying debt are all positive things, but they will have a deleterious effect on the economy in the short run. As a result, a full economic recovery may take longer, particularly if consumers remain as miserly as they were in July.

Sustainability

Similar belt-tightening economic phenomena have occurred before, but the changes rarely last. Historically, once the economy recovers, Americans go right back to their more familiar profligate spending and inattention to debt repayment and savings. In many ways, that is not necessarily a bad thing, as the health of the economy basically depends on it. However, many economists speculate that the magnitude of the most recent recession has changed Americans’ spending and debt habits permanently. Some experts believe that the debt-repayment and cautious-spending trends will continue long after the economy has regained strength.

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