This article reports that Americans in their 40s and 50s are devoting more of their discretionary income to paying off debt rather than savings or investments for retirement.
Economically, this makes good sense. Paying down debt is the same as investing; you’re giving up one asset (cash) in exchange for eliminating one liability (the debt) with no change in your net worth. The interest expense you save is, in effect, your return on an “investment” in debt reduction.
Most safe investments today pay about 2–4% in returns. Risky investments in assets like stocks have been producing losses lately. Stocks had high returns from 2009–2018, but the average return since 2000 is only 4.5%. Much of the “rally” since 2009 was simply a recoupment of huge losses from the dot-com crash and the 2008 financial panic.
Interest rates on debt are often 12–30%, depending on the type of debt. In effect, paying off debt is the same as investing at 12–30%. Your interest savings are your return on investment; there’s that much more in your pocket. While this may be a wise strategy for individuals, it’s a cause for concern in the broader economy.
Paying off debt does nothing to increase GDP, while spending and investing can have positive effects on GDP. Individuals who pay off debt are improving their personal finances, but they’re contributing to a “liquidity trap” that slows growth. Keynes recognized that when individuals don’t spend, the government may have to spend more to keep up “aggregate demand” and prop up GDP.
Washington is running $1 trillion deficits, but we may be in the “red zone” where more government debt does not produce more GDP. These individual debt reductions are a straw in the wind that we’re headed for a long period of slower growth, more deflation and ultimately a loss of confidence in central banks.
The last time this happened was the 1930s, and before that the 1870s. Get ready for another round of serious slowdowns in growth and spending.
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