Americans Are Entering a Possible Recession With Massive Debt

• The extraordinary response to the COVID-19 pandemic resulted in a broad stimulus package that amounted to approximately $5 trillion.
• While American households should have used this opportunity to correct vulnerabilities in their finances, it appears relatively few did.
• Now, with a potential recessionary cycle on the horizon, the average family must contend with soaring inflation and high debt loads.

Before the COVID-19 pandemic upturned social norms, financial advisors bemoaned that younger Americans were not taking their financial future seriously. Study after study demonstrated that millennials and increasingly Generation Z were not matching key milestone-by-age achievements – such as homeownership – set by older generations. However, the global health crisis at least superficially corrected this problem.

Suddenly, young folks who had little knowledge or interest in the stock market began piling into the sector. The grand work-from-home experiment helped, allowing millions of white-collar employees to exercise their inner Gordon Gekko. Later, the rapid valuation expansion of speculative ventures such as meme stocks and cryptocurrencies emboldened these new market participants to deepen their involvement.

On paper, young investors were applying the lessons that financial advisors have been advocating for years; that is, putting aside money for long-term growth. In reality, the lessons were applied only in a shallow or frivolous sense.

Following the unprecedented governmental response to the COVID-19 crisis, millions of households had the opportunity to correct their financial vulnerabilities. Heading into the pandemic, U.S. credit card debt hit an all-time high of $930 billion. But after roughly two years of myriad support mechanisms, this tally only declined to $841 billion, a mere 10% improvement.

Worse yet, with a possible recession on the way, U.S. households will encounter this core headwind against a backdrop of soaring inflation.

Wrong Priorities Threaten Broader Economic Stability

According to information from The New York Times, Congressionally approved stimulus bills resulted in the federal government injecting the largest amount of money into the U.S. economy in recorded history. “Roughly $5 trillion went to households, mom-and-pop shops, restaurants, airlines, hospitals, local governments, schools and other institutions around the country grappling with the blow inflicted by Covid-19.”

Of this astronomical amount, about $1.8 trillion went to individuals and families, with a majority of this allocation (over 45% or $817 billion) arriving in the form of stimulus checks. Moreover, the next biggest tally was unemployment benefits, amounting to $678 billion. The rest was divvied out to various programs, such as child tax credit expansion and SNAP and other food assistance solutions.

With so much direct cash injection into the economy, though, households should have done more in denting the overall credit card balance problem. As it stands, only about 11% of the total value of stimulus checks went toward the decline in credit-related debt. It raises the specter that perhaps a good chunk of these funds went to speculative ventures.

If so, that money could be long gone, transferring hands from one group of traders to another. Unless circumstances in the capital markets improve dramatically, many individuals and families are simultaneously facing wasted opportunities and worrying economic indicators like inflation and layoffs.

A Potential Ripple Effect

To be fair, not all households were reckless with the fiscal lifeline that policymakers provided. And in several cases, people who found themselves without a job because of the initial impact of COVID-19 had little choice but to depend on stimulus checks and the bolstering of unemployment benefits to survive. In that sense, the 10% reduction in credit card debt is a positive.

Still, it cannot be ignored that not every household needed a stimulus check. During the worst of the pandemic, the employment level declined by 16% between February 2020 and April 2020. Though severe, it wasn’t anywhere close to a 100% drop. Moreover, employment figures bounced dramatically higher in May 2020 onward.

Arguably, then, a majority of households had a clear chance to cut into the record $930 billion credit card debt. Instead, many consumers directed their government-issued funds elsewhere, perhaps hoping that the profitability of those choices could both eliminate debt and provide forward financial progress.

However, refusing to take the sure wager of debt reduction in favor of potential capital gains can lead to broader economic headwinds in the months and years ahead. For instance, without the robust influx of money into stocks to offset rising prices associated with the current inflationary environment, several publicly traded companies are forced to cut costs, translating into mass layoffs.

Eventually, these layoffs will reduce overall consumer spending, causing other revenue-losing companies to announce their own workforce reductions, thus causing a full-blown recession.

The Lesson to be Learned

An old idiom states that you should be careful what you wish for because you just might get it. For the financial advisory industry before the COVID-19 pandemic, its desire to see younger people participate in the equities sector finally materialized. While one component of this appeal was heeded, however, the other went ignored altogether: there are no guarantees in the capital markets.

Sometimes, you need to take risks in life to get ahead, everyone understands that. However, debt – particularly of the consumer credit variety – represents a liability that should have been addressed well before embattled households participated in speculative investing ventures.

In fairness, the impulse was understandable: use the money from the government to get rich quick, then eliminate the debt and have some cash left over. But this approach only makes sense if you know for certain that your trading activities will be successful. If you don’t know, then you would be taking an unnecessary risk.

Perhaps the irony regarding the onerous credit card balance is that while it initially seemed that young people learned about investing, in the end, they learned the wrong lessons, putting them in a worse off situation than before the pandemic.