U.S. consumer debt has been on a steady climb, with the latest data showing a surge of $11.4 billion during May 2024. This trend raises concerns about a potential “crowding out” effect on investment, where high debt levels and borrowing costs limit the resources available for capital allocation. However, it may not lead to a cutback in investing for retail as borrowing could actually leave idle cash for investment. Let’s explore both sides of the argument to understand the potential impacts.
Crowding-Out Effect (The Bad Scenario)
The primary argument with the crowding-out effect scenario stems from the strain consumer debt places on household finances, which could curtail investment. As debt levels rise, particularly with high-interest credit cards, which have now climbed to an average of 22.76%, a larger portion of income goes towards servicing debt instead of savings and investments. This reduces the pool of funds available for businesses to access through loans or the capital markets for stock or bond investments.
To make matters worse, the Federal Reserve’s interest rate policy seems stuck in a “higher-for-longer” environment. This means borrowing will remain more expensive for both consumers and businesses. Consumers may find it more difficult to cope even with the same amount of debt, while businesses may be less likely to invest in new equipment or expand operations if borrowing costs move up.
The Federal Reserve’s data suggests this trend of rising consumer borrowing isn’t a short-term blip. As pandemic savings have dwindled and the cost of living has risen, Americans are increasingly reliant on credit. This mounting obligation of debt diverts funds that could be used for productive investments, potentially hindering economic growth.
Boosting Demand (The Good Scenario)
Can increased borrowing stimulate investment? While the crowding-out effect is a valid concern, some argue that increased consumer borrowing can also have a stimulating effect on investment. When consumers borrow to make purchases, it can boost demand for goods and services, leading to increased economic activity. This, in turn, can incentivize businesses to invest in expanding production or developing new products to meet this rising demand.
Additionally, not all consumer debt is detrimental. Borrowing for mortgages or student loans can be a pathway to long-term wealth creation through homeownership or increased earning potential.
However, it’s crucial to consider the overall debt level and delinquency rates. The record-high $17.7 trillion in household debt, coupled with rising delinquency rates across all debt types, indicates an increasing financial strain for many. This strain can ultimately limit consumer spending and hinder the positive economic cycle fueled by borrowing.
Key Takeaway – A Nuanced Impact
The potential for consumer debt to crowd out investment is a complex issue. While high debt levels and rising interest rates can certainly limit investment opportunities, the impact can be nuanced. The overall health of the economy, the type of debt being accumulated, and how consumers manage their finances all play a role.
Economists and those choosing investment sectors monitor consumer debt trends and their impact on both household finances, as well as savings and investment activity. Maintaining a workable balance between debt and savings is healthy for both individual financial well-being and a thriving economy.
