Sunday, June 7, 2009


I read an article by “Nobel Laureate” Paul Krugman in which he berates Americans for spending beyond their means by resorting to excessive borrowing and then chastizes the Chinese for not spending enough. I believe Mr. Krugman would have served us better if he had explored why this happens, rather than preach prudence to Americans and exuberant spending to the Chinese.

In my opinion the reason Americans have been happy to go into debt to buy is that they have confidence in their ability to earn more in the future and the underlying strength of the American economy. The Chinese spend less and save more because they do not have similar confidence. Of course the present state of the economy has gone a long way to undermining America’s confidence, but we are using record new debt to correct the situation in full confidence we will be able to meet future debt obligations.

More important it is important to understand the basic assumption of debt - you buy something on credit today that you will pay from future income, but you have the purchase today. The reverse would be to save today to buy tomorrow.

My parents used to say, “we don’t use credit, we pay cash for all we buy.” The net result is that our family missed out on some important items - no television, no automatic washing machine, no vacations. Of course my father conveniently forgot about having a mortgage on his home and a lien on his vehicle.

But let’s get real. The average new automobile costs $20,000. The median American household income is about $50,000. At a saving rate of 10% it would take four years to save enough to buy a new car, if the prices stay the same. The average home price is $200,000. Thus it would take 40 years to save to buy that house, and you can be sure the home price would be substantially more.

No, even the Chinese use debt to buy homes and cars. Buying on credit is a fact of life everywhere. The only question is the proper level of debt.

Krugman and most others blame the present recession on excessive debt. They keep crying that the credit house we built is collapsing around us. But hold the phone, we now know that 97% of bank loans are being paid on time. Hardly a cause for a major calamity. Moreover, the US Government is taking on unprecedented new debt to correct the slump.
No, the basic problem is that debt is part and parcel of our modern life but we are still uncomfortable with this fact.

Leo Cecchini
June 2009

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