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Monday, June 9, 2008

Why are we still using credit cards?

According to a recent Associated Press article, Americans decreased their credit card borrowing in April. Granted, it was still an increase (meaning, an increase in the billions of dollars owed to credit card companies). However, April saw a 4.2% increase in borrowing versus 6.4% for the month of March.

Unfortunately, some Americans seem to have simply transferred their borrowing habits to other areas, like auto loans, which rose to an annual rate of 6.5%, up from 5.5% in March. Dare I hope that these auto loans represent people who are turning in their gas-guzzling SUV's, opting instead for environmentally and wallet-friendly smaller cars and hybrids?

Banks are predicting an even greater slowdown in the U.S. economy, leading to recession (if we're not already there, that is). Bloomberg published this graphic indicating that while consumers are using credit cards more often to purchase necessary items like gas and food (as opposed to vacations and clothing), due to the housing crisis Bank of America shares will decrease in value by 24%.

Meanwhile, experts urge consumers to trim their consumer debt during a recession, rather than increasing borrowing. Here's the rub, though: the Federal Reserve lowers interest rates during economic downturns, making borrowing more attractive. Lower interest rates mean that borrowing is less expensive. The detail that truly frustrates me is that the government does this on purpose, to entice consumers to borrow more!

Here's a quote from Consumer Reports, which has a very helpful list of ways to survive a recession.

"In recessionary periods, the silver lining for consumers is that interest rates often decline, making borrowing less expensive. That is entirely by design, says Sweet, an economist at Moody's.

During the 1990-91 recession, for example, the Federal Reserve gradually reduced the federal funds rate from 8 percent to 6 percent in an effort to ramp up the economy. "The reduction in short-term interest rates reduces the real cost of borrowing," notes Sweet. "This is important for stimulating economic growth, as lower interest rates entice consumers to take on additional debt to finance their consumption."

And the Fed has been on a rate-cutting spree lately. In late March, after six rate reductions since September, the federal funds rate was just 2.25 percent, down from 4.75 percent seven months earlier."

Now, I know that we live in a society in which consumption drives the economy, whether I like it or not. I choose not to contribute to over-consumption and have lowered my expenses considerably as a result. It simply frustrates me that the government continues to rely so heavily on (and even encourage) consumers fiscal irresponsibility!

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