Debt: a harsh master

If you’re in debt up to your eyeballs, you’re in good company.

The average American household is so far in hock that it now owes more money than it makes in a year. The latest figure puts average household debt at 103 percent of personal income.

Households aren’t the only elements piling up the debts. American corporations have been borrowing big bucks as well, and borrowing by non-financial firms jumped by $900 billion over the past couple of years.

As for corporations, it makes sense to borrow: the economy is growing, so why not invest in expansion? Interest rates are pretty low by modern standards, so the costs of borrowing are attractive.

And as for households, the good times continue to roll. Americans are notoriously lousy savers, and good economic times translate into more and more spending, and even more borrowing.

What we’re dealing with is the “wealth effect,” and not all of it looks healthy. The wealth effect is the simple fact that the more money you make, the more you spend.

But what is “making” money? If the boss gives you a raise, that’s a clear money-maker for you. You’re getting more cash.

But you can also “make money” without getting more cash. Anyone who owns stocks and sees the prices of those stocks rising is making money “on paper.” What goes up, of course, can go down as well, so are these paper gains really a case of “making money”? Yes and no–it could be argued either way.

But there’s no doubt that the average household sure feels richer, and much of that feeling comes from the rising tide of stock prices.

The meteoric stock market continues to stymie a lot of good minds; stock prices are in record territory here, and nobody really knows what will happen. If the market falls, though, the paper wealth that Americans were counting on will fall with it. A lot of folks will be left paying off debts they piled up when they thought they were richer than they really are.

I’ve been in debt (haven’t we all?), and it’s a bone crushing morale zapper, if you ask me. For businesses, being in debt often makes sense, and a lot of leverage (a fancy word for debt) is often a sign of good management, at least under the right circumstances.

But as for households, being in debt is no fun, especially if economic fortunes take a turn for the worse. A lot of us learned that lesson the hard way when a recession rocked California a decade ago. As a result, to this very day, a lot of my friends and I refuse to go into debt at all, at least for consumer goods.

Most of America, though, is happily piling on the debt. It’s a risky way to live, and it will accelerate any economic downturn that might be triggered by a stock market hiccup.