For pretty much everyone under the age of 45, they haven’t seen interest rates (aka cost of money) at these levels during their adult lives EVER. The last time mortgages were at 8 percent it was in August 2000 !!! The prime rate of 8.5% hasn’t been this high since 2001. Average credit card interest of 22 percent hasn’t been at these levels pretty much ever. Basically, the cost of borrowing (as we call it debt) has swung from a smart financial move to an unaffordable one. 5 years ago, many of our clients used home equity loans to add to their homes, consolidate debts, or use for projects because it made financial sense. Today, they are being paid back quickly as the logic for debt isn’t there. For people with strong balance sheets, utilizing debt is financial engineering. The problem societally is that for many, use of debt has been a tool to increase consumption (spending) and the balances are not easily paid back. This has now become a problem as home equity loans, credit card loans, car loans, mortgages, and personal loans have all increased beyond the ability of average Americans to handle it. If you look at the basic auto loan (85% of all car sales are done on credit), the interest rate is 9 percent, and the average loan amount is over $40,000. The average monthly payment is almost $800. One might call a car a necessity and if so, its cost must be paid, and other things may not get bought. The seeds of a consumption driven economic slowdown.
Prior to this economic cycle, debt was easily used to supplement spending because it was essentially free. Carrying a balance on the old credit cards didn’t seem so awful when the cost was “minimal”. Same with stroking a check for a HELOC loan when the rate was 2 percent. Those days are long gone. People (smart ones anyway) are going to pay off (or at least pay down) debt. Everyone will spend less as to not add to the credit card balance. On the aggregate, economic consumption will decrease. Some people will get “downsized” but (our opinion) it won’t be as bad as prior because companies didn’t (or couldn’t) add to headcount at a rate as in prior expansions. Regardless, belt tightening will be the new norm and economic choices will be made, just like the “old days”. Once this gets ingrained into the psyche of society, there will be a slower economy for a few years to come. Will be a new habit and habits die hard.
The economic retrenchment is already starting to happen. As in the past, it will be painful (or worse) for some. On the other side, it will actually be beneficial for others. Young people, especially those who aren’t (or haven’t) lived to a budget, will get hurt. Especially for those who have been living beyond their means and now have excessive debt to handle. An entire generation of folks who grew up on free money are going to learn hard lessons. Compound that with the looming student loan restart and many (not all) of Millennials and Gen Z’ers are in a rough spot.
As with most things the economic consequences aren’t all one sided. For those who have lived within a budget and within their means it won’t be awful. Yes, inflation has pushed up prices but without a large debt overhang, costs are generally controllable. With interest rates being higher, people with excess can now get a good return for cash or short-term savings. Cd’s, Treasury Direct, or other cash equivalents are yielding 5 percent or more. Rates we haven’t seen since the year 2000. Finally, savers and cash flush retiree’s can get return without major risk. As the economy slows, prices will come down and people with strong cash flow will be in a position to take advantage.
Looking ahead, the advice remains the same. Have a financial plan and review it periodically. Keep your investment portfolio balanced. Avoid debt, especially high interest variable rate debt. Last (and not least), as the financial media starts its “doom and glooming”, don’t buy into the narrative. Things are never as good (or bad) as they seem, and the scare stories will be worse than the reality. The investment markets will be in recovery mode well before the economy gives the all clear data and (in our opinion) that’s not too far off.
As always, stay well and enjoy the Fall season. If you would like to chat further, don’t hesitate to reach out.
Ed, Frank, Tammy
Edward Stiles
200 N Union St.
Kennett Square, PA 19348
cell 610-745-1931
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