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Tuesday, December 2, 2008

From Leverage to Income: Why Our Economy Has a Long Way to Go

Lost in the confusion and sophistication of the initial financial bailout in September was something very revealing about our economy. Politicians were constantly referring to companies not being able to meet payroll unless banks were able to get short term lending.

This should have in and of itself been a startling wake up call to the manner in which our economy operates. If a company needs to constantly receive short term lending in order to meet payroll, does this sound like a viable operation? Furthermore, the epidemic which created an entire market for companies that used short term lending in order to cover payroll was a symptom of a much bigger American problem. Our economy was drifting farther and farther into a leveraged economy.

The average American family has just over $9,000 in credit card debt.

Americans are loaded with credit card debt.

The average American household with at least one credit card has nearly $9,200 in credit card debt, according to CardWeb.com, and the average interest rate runs in the mid- to high teens at any given time.


Many of these families are paying the minimum on their way to a lifetime of never ending debt. To add to this, the last four years brought about a new form of leverage. Americans were using new found equity from the inflated prices of their properties to borrow agains their homes.

The so called credit freeze has revealed a much more sinister American problem. We have all gone far too long with far too much debt. Our economy had become dependent on the sort of artificial growth that comes from using someone else's money and the leader of this pack was the federal government itself, with debt currently just over $9 trillion.

Now that the economy has slowed down, many folks, businesses, banks, and consumers are re thinking the manner in which they have maintained their finances for far too long. Everyone is afraid to spend not merely because they fear the future of the economy. They are afraid to spend because they are all re thinking the manner in which their finances have been handled. The by product of this economic malaise will likely turn most of America from a borrowing nation to a saving nation. In the long run, that is very healthy. Unfortunately, while Americans from businesses to consumers are hoarding their cash away, this will only go to further weaken our economy.

Over the next several years, what you are likely to see is a significant reduction in everyone's debt. Once this is over, the economy will not only recover but the recovery will be very healthy. Until then though, it will be a painful economy. That's because everyone will go through a long painful process of reducing their debt load. The problem is that this debt load is layered. Even those that are owed also owe someone else. For the next several years, we will be paying for the excesses of many years prior. The process is ultimately good...call it a cleansing, but it is very painful as we go through it. It will be much like a heroin addict that quits cold turkey and goes through withdrawal. It will be excruciating pain while the process is happening, but ultimately we will all be healthier at the end.

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