The Ticking Time Bomb Behind Strong Retail Sales

This morning’s retail sales data were yet more evidence of what is probably the most remarkable phenomenon that I have witnessed in my forty years or so of association with financial markets around the world. It has always been believed that U.S. consumers are resilient, but over the last year and a half, as the Fed Funds rate has gone from zero to around five percent, they have exceeded themselves. Americans have shrugged off the impact of higher interest rates and are still spending at a rate that would be impressive even without rate hikes. The questions for investors, though, are whether that is sustainable, and whether it can be enough in the long-term to allow for the “soft landing” that many now seem to think is possible.

The reasons spending has held up so well are hard to define, but most people believe it is in part down to a kind of “YOLO” attitude engendered by living through a pandemic that, for a while, felt like a very real threat to our existence. It reminded us of how short life can be and, if death is lurking on every counter and door handle or is in the very air we breathe, why not buy what we want now and worry about it later? Add in the effects of e-commerce that has made spending even more convenient than ever and seemingly painless in the short-term, and you have circumstances where spending can exist independent of economic conditions for a while.

It cannot, however, do so forever. The reason it cannot is made clear by even a cursory glance at one chart:

In the time that the Fed has been forcing interest rates higher, outstanding credit card debt in the U.S. has soared up more than 30% in less that two years to above the $1 trillion mark, as explained in detail in this New York Fed report. That is in part due to higher rates themselves increasing balances, but it is presumably also a product of that “buy now, worry later” mentality of American consumers. Lest you think that is nothing to worry about, the last time we saw such a spike was in 2006 and 2007 and we know how that ended.

Credit card debt is one of those things that is not a problem until it is. Wages have climbed, and debt as a percentage of household income is not climbing anywhere nearly as steeply as a result. But as we found out in 2008, it only takes a wobble in the banking system for high credit card debt levels to become a major problem. If banks feel a liquidity crunch, they will rein in some of that debt and, when they do, it will have an immediate, exaggerated impact on an economy that increasingly relies on it to fuel growth.

None of this means that anyone should panic. Banks are generally in much better capital reserve and liquidity positions now than they were in 2008, which means a reduced chance of the kind of credit crisis we saw then. However, what it does mean is that at some point, the merry-go-round has to stop. We cannot continue to fuel growth by consumers spending money that they don’t have. If that reckoning happens gradually, there is still a chance that households adjust slowly and cut back on debt and that we all live happily ever after. History, however, tells us that such spending sprees don’t usually end well.

The next time you hear somebody wondering at the continued strength of the American consumer, ask yourself a question. Is it really strength, or is it simply even more accumulation of debt? When talking about government debt, it is often pointed out that governments aren’t households in that the power to tax and to print money enables them to carry huge amounts of debt without it being too much of a problem. The opposite is also true, though: households aren’t governments. They don’t have those powers, and their debt can be called at any time. We live in a unique moment in history, where events have conspired to make debt seem logical and understandable. It is, but it has a cost, and investors should not forget that. 

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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