We'd gladly go into debt to save the economy but those bad banks won't let us

09/09/2009 5:08 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

U.S. consumers cut back on borrowing by a record $21.6 billion in July. According to the Federal Reserve, consumer credit fell at an annual rate of 10% in the month. That’s about five times faster than the contraction that economists were expecting.

That’s great news if you’re a debt vigilante watching to signs that we’re finally going to give up our addiction to credit and live on what we earn.

It’s really bad news if you’re an unemployed worker looking for a job or an investor betting that the economy is in recovery mode.

If consumers aren’t adding new debt, they aren’t buying. And if they aren’t buying companies won’t be looking to hire the army of unemployed. The official unemployment rate hit 9.7% in August. Bad enough. Add in all the workers who are so discouraged that they’ve stopped looking and those working part time but who want to work full time and the rate is 16.8%.

Before the Fed reported the data on September 9, the consensus among economists was that consumer credit would contract by just $4 billion for the month. That relatively small contraction—on a total of $2.5 trillion in total consumer debt—was regarded as evidence that the economy had bottomed.

Apparently economists don’t open their own credit card bills and they underestimated the speed with which banks are cutting credit lines. A survey of bank loan officers found that 35.2% said they had “tightened somewhat” their lending standards. In real life, given the propensity of survey subjects to sugar-coat their answers, that means banks have been taking an ax the size of Paul Bunyan’s to credit card credit lines.

(Not to brag but I’ve had banks cut the credit line on two of my credit cards by 50% and 60% respectively. In the last two months. Beat that, if you can.)

Economists are somehow staying optimistic in the face of this plunge in consumer credit. I think it’s a tribute to the human ability to maintain two contradictory thoughts in the mind at once.

Economists surveyed by Bloomberg in the first week of August, predicted that consumer spending will grow by 1.5% in the second half of 2009 after growing by just 0.2% in the first half of the year.

They also believe that the jobless rate will average 10% in the first quarter of 2010. Let’s see, the jobless rate will go up from 9.7% to 10% and those jobless workers will spend more. Got it?

They also predicted that the economy will return to positive growth in the second half of 2009.

And that annual growth in consumer spending won’t hit 2% until 2011.

If banks keep cutting credit lines—and some banking analysts on Wall Street are projecting that consumer credit will drop by another 20% by the end of 2010—you can throw all those projections out the window.

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