I was at a function yesterday with a bunch of economists – amongst some other people – and was annoyed to note that there wasn’t much push-back against the casual assumption that the cash handouts had not worked – that people had just saved the money they were given. It all seems so logical, what with people’s confidence being down and all, and indeed what with household savings rates having shot up. At one point one of the participants in the discussion said that many people would use it to pay off their credit card debt.
Now if they use it to pay off their homeloan, I would agree that the money is likely to be saved quite possibly for a considerable time. But the claim was made that ‘they only used to pay off their credit card. The thing about using money to pay off outstanding credit card debt is that there are two classes of credit card debt. The first is the very temporary rolling one month debt of those people who pay off their balance in full every month. If they used the money to pay off that debt – then the money will shortly turn up in their bank accounts – because they’ll have less money taken out of their account the next month – having paid $950 of it off already. The next question is what happens to the money when it’s in the bank account. My guess is that most of it would be saved – because these are fairly (financially) rational people. But of course even in this cohort, the owner of the regularly paid off credit card (or their spouse) might still have a relationship with their outstanding bank balance a bit like Oscar Wilde who said that he could resist anything . . . except temptation.
But what of the others, who don’t pay off their credit card each month? Pardon me for being so blunt, but they’re the mugs that the banks are counting on to make credit cards so lucrative for them. Here they are, often paying off their home loans, often with substantial equity in them which would enable them to reborrow. And they choose instead to pay 13 odd percent interest on their credit balances under their cards. Even if they don’t have equity, it’s habits like this that have led them to not having it. A tight month or two could enable them to join the club paying no interest on their credit cards. But they’ve not done this.
Do these people (they may include you), sound rational to you? Would you want to apply the ‘permanent income hypothesis‘ to predict their expenditure, or would you think that their expenditure smacks of adaptive expectations – that (within or without various longer run savings routines like paying off their homeloan and perhaps salary sacrificing some portion of salary) if there’s a bit more money around, it gets spent? If that’s not the case how (the hell) did they get to be paying 13% interest. If you were sympathetic to my reasoning, you wouldn’t expect to see all the monty spent the month it turns up in the account, but over a series of months as the credit card seems so much shier of maxing itself out.
So I think an important metric is what proportion of people pay off their credit card in full. They may not be incredible calculating machines, calculating their permanent income requirements every hour of the day, but they do at least pass a basic standard of rationality – they’ve noticed that paying 13% interest is something to avoid if possible and convenient.
I asked someone in one of the major banks what the figure was. What do you reckon it is?
“I asked someone in one of the major banks what the figure was. What do you reckon it is?”
Depends who you asked, whether they actually knew the answer, and whether they were lying. I have no way to evaluate these factors.
The Citi survey in 2006 indicated about 50%.
But that was then and this is now. So who knows?
So setting the data quality issues, what did the person say?
So setting aside the data quality…
You’re right SJ – if they were lying, there would be no reason to trust them.
If people never trusted liars then everybody would tell the truth.
[…] Here is Nick today, complaining that there is no push back to the idea that the December stimulus failed. Now if they use it to pay off their homeloan, I would agree that the money is likely to be saved quite possibly for a considerable time. But the claim was made that they only used to pay off their credit card. The thing about using money to pay off outstanding credit card debt is that there are two classes of credit card debt. The first is the very temporary rolling one month debt of those people who pay off their balance in full every month. If they used the money to pay off that debt – then the money will shortly turn up in their bank accounts – because theyll have less money taken out of their account the next month – having paid $950 of it off already. The next question is what happens to the money when its in the bank account. My guess is that most of it would be saved – because these are fairly (financially) rational people. But of course even in this cohort, the owner of the regularly paid off credit card (or their spouse) might still have a relationship with their outstanding bank balance a bit like Oscar Wilde who said that he could resist anything . . . except temptation. […]
What is wrong with saving anyway? The money is put back into the financial system for other people to borrow. I thought that a bit part of the problem is lack of landing capacity in the system so people can’t get bank finance for normal commercial operations.
PS Who is going to bail out the US when it goes broke? When it is officially realised that it is broke I mean.
The RBA’s credit card statistics show that consistently more than 70% of the outstanding debt is accruing interest. It’s hard to infer from this what proportion of card users don’t repay each month, but it is consistent with a large percentage.
There were however larger than usual repayments in December 2008, equivalent to 18% of the outstanding debt, compared to 14% in November. Total debt continued to rise, however, The January figures will be interesting, as Xmas makes it hard to see the longer-term underlying trends.
My guess is 80% of people pay off their monthly credit card balance in full.
As an aside I notice my Virgin credit card has just morphed into a Westpac credit card. I’m most unimpressed as as my almost luminous bright pink Virgin credit card was such a good talking point.
Nick, I am someone who invariably pays off my credit card each month because I really resent paying exorbitant interest to the banks. However, when I first had a credit card (early 20s) I was terrible, and maxed it all the time, until my best friend pointed out that I was just throwing money to the bank for nothing…
A credit card is something which helps you deal with cashflow issues, not a surrogate for cash. I guess it depends what proportion of the population uses a credit card in this way. Maybe 50%? Although my experience as a banking litigator tells me that there’s an awful lot of people out there who don’t manage money wisely.
Rafe, I was also wondering what the problem is with saving?
“I was also wondering what the problem is with saving?”
LE, the paradox of thrift is a traditional answer to your question: http://en.wikipedia.org/wiki/Paradox_of_thrift
But I’m now leaning towards Steve Keen’s view that Keynesian pump priming is not going to get us out this hole:
“Not well. Rudds stimulus is a whopping $42 billiona big number. But our private debt is now over $2 trillion. If the private sector de-levers by as little as 5% of its current debt level, that will withdraw $100 billion from spending. In the new economic Rock vs Scissors game, Deleveraging trumps Government Stimulus every time.
This is why Japan is still mired in a Depression, 19 years after its bubble economy burst. You cant solve a problem caused by too much debt by going into more debt. Ultimately, the only solution is to reduce debt.”
http://www.debtdeflation.com/blogs/2009/03/05/after-our-economic-dunkirk/
Note Keen’s extreme pessimism. I think we are in for a long miserable ride and what happens in America and China etc is much more important than what happens here.
The Australian seems to be reporting that the retailers are happy with the additional spending so somehow or other the money is moving around. Whether buying yet more imported consumer junk is the answer remains to be seen (probably cheers up China some microscopic amount).
http://www.theaustralian.news.com.au/story/0,25197,25132845-5013871,00.html
I hasten to add that the basic belief of any trade is that for the trade to be valid, both sides must enter into a voluntary agreement. Under this presumption, the exchange of goods is known to have been a nett benefit to each party (i.e. win/win) otherwise one side or other would have declined, and no trade could occur. Following from this, more total trade is better than less because it implies that more parties are benefiting (more win/win events occur).
The moment you attempt to coerce (by whatever means) someone to trade who would not have otherwise done so, you have broken the very measure of “better” and “worse” in the macroeconomic system. More total trade might be better than less total trade, or it might be worse, but no one will know which is which because the participants can no longer make decisions for themselves. The entire concept of someone saying, “I’m spending this not because I really want to but because it helps the economy” is a complete denial of the most fundamental economic axiom.
I’ll also add that in a nonlinear system, there’s no reason to believe that many small exchanges actually add up to any particular result, so strictly speaking the theory was broken to begin with (but we all pretend to believe it, so I might as well pretend to be shocked to see people ignoring it). We could refine that a bit and say that the theory does work for systems that are reasonably close to linear, and as a general rule mechanisms for coercion (e.g. one time windfall payments, followed by cranked up tax down the track to pay it back) make the whole system MORE non-linear, and thus even harder to build a working theory for. Such mechanisms also make it more difficult for the rational participants to remain rational given that they are aware that the rules may arbitrarily change at some random future date.
In short, saving is bad when everyone is saving, because all saving is someone else’s spending. It is simple accounting that everyone can’t save at once.
In terms of savings led investment…
Borrowers (absent perverse incentives like in the US) borrow if they expect they can repay the loan. This means being sure they have a job, or more improtantly, if they can get a return on their investment.
Banks (well, Australian banks) will try to only lend to people they expect to pay the loan back.
In an absurd scenario, the interest rates drop to zero as to be below expected return to spur investment, which removes incentive to keep bank deposits as an asset in favour of foreign currency and/or cash under the matress. For “absurd” read “Japanese”, although money isn’t actually kept under the futons.
In short, investment is based on a wealth of signals about whether the return is possible, especially regarding expectations of each other’s behaiviour, not a single one based on the availability of funds.
Which is why I can never understand Austrian macroeconomics. Austrian microeconomics does a good job of describing the infinitely complex amount of tacit information and price signals that allow individuals actions to co-ordinate complicated systems, but the macro relies on the idea that people have a mindless stimulus-response to a single signal.
Cheap money -> invest!
That’s even cruder than the primitive form of the consumption function!
“Cheap money -> invest!”
No, cheap money means borrow to invest AND consume for SOME players and in terms of investment, those with longest paybacks become cheapest quickest- eg RE. However there is a caveat that Austrian economic analysis understands implicitly in this process and that is what happens at the margins. I would never dream of borrowing for consumption (eg consumer credit) and never have. In fact once when travelling with the family for a long trip (prior to electronic banking) I transferred a significant amount of holiday money into my Bankcard beforehand, to find to my surprise I had earned interest on that money at a rate above my normal savings account rate, although I doubt that is the case nowadays. Consumer credit is a once off sugar hit and I have only ever borrowed to back myself in business or avoid paying rent. That is a rule I instil religiously in my offspring, although I might relax that for a daughter buying a first new small car, as the interest is probably worth paying as a tradeoff for the new car warranty and mechanical reliability. ONCE only!
While my Austrian habits are of fleeting interest from a microeconomic perspective, it is as Nick points out what happens at the margins to large numbers of actors that are important to macroeconomic performance. Throw me $900 of tax clawback and it will go straight into the bank and stay there. Whether the bank will lend it will depend on whether they want to and whether there is someone who wants to borrow it. Price is an important consideration, but alas not everything if many of the actors have inherited some past economic baggage. Money is cheap now and getting cheaper but there are more bank takers than their customers nowadays and Austrian analysis explains why that is the case for such large numbers at the margins. Economic actors as a whole are much more sophisticated than they were in my grandma’s day and so this fiscal stimulus and public debt is all to no avail. There is the question of demographics impacting here to be sure, but most of us know intuitively the macroeconomic Austrian lesson now. The party is over and the years of malinvestments must be unwound now and there is no escaping it. The layoffs are increasing at a frightening pace now and Australia is hurtling into depression with Govts impotent and frozen at the breathtaking rapidity of it all. All they can do is give money away at zero interest in the last futile gesture of the total bankruptcy of Keynesian economic thinking. Fiat money is not now and never was real savings for investment or consumption and without that consumption must fall and falling it is.
Here’s a curly one for you to mull over at present. Recall what I said about daughters and borrowing for that first new car. A friend’s 21 yr old daughter has finished uni and started her first permanent job as an in demand professional in the country, about a 2 hour drive from Adelaide. As a result of an inattentive P plater colliding with the rear end of her old car it’s an insurance writeoff and she needs a repacement urgently. Dad is old school like me and recommends a secondhand replacement with limited borrowing while daughter has become aware there are lots of new vehicle dealers and her Big4 bank only too willing to accomodate her with a new one. I did point out to dad that some of the cheap small cars on the market make sense for girls, particularly with safety features like ABS and EBD braking in cars like the Nissan Micra for $15k as she’s travelling a fair bit in the country now. The only snag is I’m only too well aware of an economy spiralling into depression, although demand for her skills should make her a reasonably safe bet. Her bank has approved a loan which I assume would be at least $15k and probably more like $20k+, but their interest rate was 13.4%. I raised my eyebrows at that rate and relayed that I’d heard CUs were the cheapest money going. Too right as it turned out mum and dad’s Satisfac CU offered her 7.8% with no penalty for faster loan repayment.
Now therein lies the conundrum. Is her Big4 bank simply trying to bookbuild here with clearly discouraging interest rates for borrowers, or does the bank really know something the CU doesn’t? I’ll leave you to work that one out but my hunch is the bank knows best either way.
I suspect P.T. Barnham’s thesis contains the missing knowledge. There are some really good value second hand cars out there right now.
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