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Essays & Articles |
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July 12, 2006 by Gary North, Ph.D.
For those of you who have control over your finances and who use your credit card -- only one -- to make purchases that you pay off 100% each month, this report is not crucial, although it may be enlightening about how most people live but ought not to live. For those of you who are not in this minority category of consumer, this report will be useful if followed and self-condemning if not. You can take a personal credit card self-test to see how deep you are into credit card quicksand: I realize that most people think, "I'm OK. I don't have a credit card problem." Fine. But it wouldn't hurt to take the test, would it -- I mean, if everything is just fine? "But I don't really want to know." I see. Because of the insidious nature of debt, it usually begins innocuously. You buy something that you really don't need. You charge it on your credit card. You don't know how much interest your card charges. You have never used a compound interest calculator. You don't understand that debt is like quicksand: easy to get into but difficult to get out of. The reason why there are so many credit card ads in college newspapers is simple: The companies have spotted their marks. They have an audience of people who are legal adults -- some just barely -- who are now old enough to sign a binding contract. Before age 18, you cannot get a credit card because your promise to repay the debt is not legally binding. Minors can get debt cards such as VisaBuxx. These allow purchases by plastic, but only to the limit of the money deposited in the card or in a bank account. College students are not stupid. But, with respect to debt, they are ignorant. They have had no experience with debt. They don't know how difficult debt is to use productively. For most people, a debit card is the only plastic that they will ever need, with one exception: car rentals. There, you must use a credit card, because the rental company wants to hold the hammer in case you don't return the car on time. The advantage of a debit card is that it keeps you from stepping into that quicksand. You may not budget your expenses carefully, but it stops you, once you reach the limit in the card. This is what a wise parent provides for his college-bound offspring, who is no longer legally a child. The parent controls the subsidized spending. Then he warns the subsidized party to learn how to budget or suffer the consequences. The student can still get a credit card on campus. This is why parents need to discuss the nature of debt's quicksand characteristics before a child reaches age 18. The offer of "instant credit" is tempting for too many untrained students. One of the obvious holes in the American high school curriculum is a course segment on interest and debt, meaning the time value of money. If there is a step-by-step internet-based course on the time value of money for beginners, I have not found it. On Not Keeping Up With The Johnsons A few years ago, there was a TV commercial for a debt-consolidation company. It featured an always-smiling man who brags about his large home, his golf course membership, and his new barbecue grill. Then we see him on a riding lawn mower. Still smiling, he says, "I'm in debt up to my eyeballs. I can barely meet my monthly payments. Won't somebody help me?" His name was Stanley Johnson. There are millions of Stanley Johnsons out there. They seem to be doing well. What their friends and neighbors don't see is Stanley or Stanley's wife struggling at the end of the month to make payments to credit card companies. The Johnsons' pain is great. So is their fear. For some people, spending is an addiction. Like alcoholics who drink when under pressure, they spend when under pressure. This increases their future pressure. It is a self-reinforcing downward spiral. It is quicksand. Every time you see a garage sale, remind yourself: Someone paid retail and then paid 18% per annum -- and may still be paying it -- to buy a driveway or a garage full of junk. That person is now unloading the debris for pennies on the dollar. It costs more to store it than it is worth to the owner. This is the grim reality of debt: a accelerating burden for depreciating assets. There will be buyers for some of this garage sale debris. For some people, it will be worth a few cents and storage space to pick up a bargain. Buyers will not use credit cards. They will pay in cash. Buyers who have currency to spend are in a better bargaining position than those who don't. The best use of any money made by a garage sale is debt reduction. If you find yourself in the position of Stanley Johnson, it's time to get help. There are debt consolidation companies out there. Some are better than others. Your first step is to get a tight grip on your spending. This means that you have to find out where your money is going. If you have a copy of Quicken, use it to find out. But it's going to be painful to enter the information retroactively. You may not be a careful collector of receipts. You credit card statements are the place to begin. Maybe you want third-party assistance. There is an organization that can help you: the National Foundation of Credit Counselling. Its site has a zip code search engine that you can use to locate a local counsellor. You don't pay for the initial consultation. One very useful tool that can help you face up to financial reality is MSN's debt repayment calculator. It takes a you through the basics of your debt situation and then tells you how much you must allocate each month for debt repayment in order to achieve your goal of debt-free living (other than your mortgage). You tell it how long you want to take to achieve this goal.
Going Cold Turkey If you are into the second half of the debt quicksand list, begin with a ritual: Cut up all of your credit cards except one -- the one you may use for renting a car. Put that card in a safe place other than your wallet. If you must use plastic to make purchases, go to your bank and get a debit card. If you don't have enough money in your account to serve as a spending reserve for a debit card, then you are already in desperate shape. You can't afford a credit card. It would be like an alcoholic with access to booze by running up the tab. Bartenders know better. Credit card companies know, too -- that most people will not declare bankruptcy, and that they will be paid their monthly pound of flesh, though maybe not every month. Warning: Don't cancel your cards' accounts when you cut them up unless you know that you are a true debt junkie and your credit is close to ruined anyway. Just stop using the cards. Pay off your debt. Cancelling your card accounts lowers your credit rating by reducing your line of credit in relation to your existing debt. The credit rating system is geared to getting you into quicksand and keeping you there. This is why you should never have gotten more than one credit card or retail credit account. If you have elected to avoid bankruptcy -- wise -- and also to pay off your cards 100% -- equally wise -- don't cancel your accounts. Pay them off and leave them at a zero debt balance once you have paid them off. This makes your credit report look good: a large credit line and a zero balance owed. There is an organization for seriously addicted debt junkies that is modeled after Alcoholics Anonymous: Debtors Anonymous. I realize that most debt junkies will not admit to themselves that they have a debt addiction. Like alcoholics before their "moment of truth," they think they can quit whenever they want to. Like that subcategory of social drinkers who are on the way to alcoholism, the debt- addicted person waits until it is close to too late to admit to his addiction. Of course, most drinkers are not alcoholics, and most debtors are not addicted. But if you find that you really cannot bring yourself cut up your credit cards, and you just cannot seem to follow the program recommended by an NFIC counselor, stronger measures are called for. Just One More Goodie Economics teaches us that we allocate our next dollar to something worth less to us than what we spent our previous dollar on. This is the law of decreasing marginal utility. One implication is that the next goodie will be worth less to you than the goodies you just bought. Meanwhile, the old goodies keep depreciating. Conclusion: He who dies with the most toys is a really big loser. For most people most of the time, one more goodie is marginal. We are rich. By all standards in history, a middle-class American is richer today than the rich were a century ago, except for two things: their real estate holdings and the number of servants. In terms of entertainment options, medical care, educational options for bright children, transportation, communications, and tools of production, what American would trade his present circumstances for those enjoyed by John D. Rockefeller in 1906? You might think, "I would not have to work any more." But Rockefeller, as with most super-rich men of his era, stayed on the job for years beyond age 65, despite his wealth, and he had to work hard in old age to see to it that the money he had amassed was put to uses that he approved of. He had great responsibility, and he felt it greatly. So did most of his peers. A middle-class American does not have the level of comparative responsibility, yet he has better toys. The debt junkie does not appreciate this. He is addicted to more. But obtaining more only adds to the addiction. We tell our children that money isn't everything, that what they are is not revealed by what they own, that they should save for a rainy day. Our parents told us these things, too. Western civilization was built on truths like these. Yet parents also warn children: "Do as I say, not as I do." The problem is, children are more likely to do what their parents do rather than what they say, if there is a conflict here. Conclusion Getting out of credit card debt takes a great deal of self-discipline. The issuing banks are happy to keep you sinking into more credit card debt. You get out of debt the same way you eat an elephant: one bite at a time. You start where you are and resolve to pull your way out of the muck, one debt-repayment check at a time. If you have any savings outside a tax-deferred retirement account, liquidate them and pay off the cards. This sounds radical, but it's good advice. High interest payments are relentless. You can invest later. Right now, you are dis-investing. You are on the wrong side of the credit table. Get on the other side as fast as you can.
Dr. Gary North earned a Ph.D. in history and is one of America's keenest economic analysts and commentators. He supports the Austrian school of economics and is a previous assistant to libertarian congressman Dr. Ron Paul. Visit his website at http://garynorth.com. To subscribe to Gary North's Reality Check go to http://www.dailyreckoning.com/sub/GetReality.cfm. If you enjoyed this essay and would like to read more of Gary's writing please visit his website at http://www.garynorth.com or http://www.freebooks.com.
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