America's Debt Bubble

The Federal Reserve Bank of New York released its latest report showing that total U.S. household debt went up by $117 billion from the third quarter of 2014 to the fourth quarter. As of the end of 2014, total household debt stood at $11.83 trillion.

Total household debt increased $306 billion from the previous year, with the biggest increase coming from mortgage debt. But virtually all major forms of debt were up across the board, including student loan debt, auto loans, and credit card debt.

Out of the total $11.83 trillion dollars, mortgage debt made up $8.17 trillion of this. It is not surprising that mortgage debt would account for almost 70% of total U.S. household debt. Student loan debt comes in a distant second at $1.16 trillion. Then there is auto loan debt at $955 billion and credit card debt at $700 billion.

While the increase in debt over the last year is not huge, it is a somewhat disturbing — although not surprising — trend that we have seen before. In the early and mid-2000s, there was a big run up in debt, particularly in mortgages. We know how that ended.

After the fall of 2008, household debt actually went down. It was part of the deleveraging. While some of this was due to the housing bust and the huge number of foreclosures and short sales, it isn’t the whole story.

Americans, concerned with the economy, actually paid down debt. Credit card balances went down as a whole. And despite the record low interest rates, Americans were not anxious to take on new loans.

Unfortunately, that trend may end up being a blip in the history books. It seems that Americans are starting to gain a bit more confidence in the economy, which to many is a green light to take on more debt.

A Look at the Fed

Perhaps it is ironic that this report is released from the Fed Bank of New York. It is the Federal Reserve itself that we have to look at when discussing these statistics.

The Fed had a loose monetary policy with artificially low interest rates in the early to mid-2000s. When Ben Bernanke took office as Fed Chair in early 2006, he actually tightened monetary policy. But this just served to expose all of the previous misallocations, which eventually led to the bust.

Once the economy tanked, Bernanke abandoned his tight-money stance and became the biggest money printer in Fed history. He oversaw QE1, QE2, and most of QE3.

2013 and 2014 saw the bulk of QE3, which was the biggest of the three rounds of monetary inflation. While much of this newly created money went into bank reserves, it still has had its effects on economic activity.

It should not be surprising that household debt has begun to rise again. While it has not yet reached the peak of 2008, the trend is clearly up at this point.

It may be easy to blame the American people as a whole, but the Fed is the real culprit here. Its policies encourage this kind of behavior. Interest rates are near zero, so people are only going to tolerate leaving their money in a bank for so long. Even if price inflation is at a relatively low 2%, you are still losing purchasing power every year if you are “earning” an interest rate of just 0.1%.

It leaves little choice for Americans. Instead of leaving money in a checking or savings account, you can seek riskier investments such as stocks. This is probably one reason why stocks have done so well over the last several years. Another option is to buy real estate, which of course will lead to more mortgage debt.

Some Americans will choose to just spend their money or take on more debt. Why not buy that new car now and lock in a low interest rate?

It doesn’t seem to be doing much good just putting a little money away into a checking account. As long as Americans feel secure in their jobs, this is the attitude that some people are going to take.

While it may seem irrational on a certain level, it is actually somewhat rational given the incentives imposed by the Federal Reserve. When you create money out of thin air and interest rates are low, you will tend to get more people taking on debt, especially if they are not too fearful of the near future.

Government Debt

In general, Americans are actually pretty good at managing their debt.

This wasn’t so much the case with the housing bubble and bust, but that was more of an exception. In terms of keeping debt manageable, most households actually do a decent job of not letting things get too far out of control.

The same can’t be said for the federal government. While $11.83 trillion seems like a lot of household debt, it is lower than the national debt that the government has accumulated on behalf of the American people.

The current national debt stands at over $18 trillion. This doesn’t include the unfunded liabilities, which have been estimated as high as $200 trillion.

In other words, Americans are more indebted to their own government than to all other creditors combined. Every U.S. resident “owes” about $56,000 for his or her share of the national debt. This includes everyone, even children.

U.S. household debt is much lower than this. And when you consider that the majority of U.S. household debt is in the form of mortgage debt, Americans actually have a house to back this up. As long as you are not underwater on your house, you could sell it at any time and clear your mortgage debt.

What does the government have to back up its debt? It has the ability to tax more and create more money out of thin air in the future.

Don’t Be Tricked

The government and the Fed really do encourage Americans to take on more debt. The good news is that you don’t have to be tricked. You don’t have to be a victim.

This isn’t to say that you shouldn’t take on any debt. If done in a manageable way, it is certainly a good tool, especially when you’re considering buying a house.

But don’t let the low interest rates discourage you from saving and investing. You have options besides keeping your money in the bank and earning next to nothing. It is important to diversify your assets, at least to a certain extent, to protect your wealth.

This includes buying gold-related investments that will serve as protection against a depreciating currency. While households will manage their debt, the government will not do so well.

Unfortunately, the solution will be more monetary inflation down the road. This is why it is important to own some hard assets that protect your purchasing power.

If the Fed acts anything like it has over its 100-year history, there will be periods of loose money and tight money. There will be booms and busts. We can’t get suckered into taking on too much debt during the boom times. We also have to protect ourselves against an eroding dollar.

This means diversification, which includes some gold investments and other hard assets.

Until next time,

Geoffrey Pike for Wealth Daily