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How does consumer debt erode the U.S. middle-class?

Most Americans lament that the middle-class is disappearing. And their lamentations aren’t unwarranted. Indeed, the middle-class is shrinking considerably. The American middle-class, once the economic stratum of a clear majority of American adults, has steadily contracted in the past five decades. The share of adults who live in middle-class households fell from 61% in 1971 to 50% in 2021, according to a Pew Research Center analysis of government data.

U.S. Social Class Tiers, 1971-2021

Source: Pew Research Center

This suggests that the percentage of low-income and upper-income households increased within these five decades. The low-income tier increased from 25% in 1971 to 29% in 2021, and the upper-class tier increased from 14% in 1971 to 21% in 2021. Many Americans have been saying that the exponential decline of the middle-class is due to a rigged system that favors the rich at the expense of the poor. This is the main argument of Sen. Bernie Sanders and his socialist acolytes and they believe that government must do something to fix this socioeconomic doldrum. The fundamental reason why the American middle-class is gradually eroding is because of its use of consumer debt, also known as household debt.

The United States is a society that functions on credit. In America, spending is done within the buy-now-pay-later paradigm. Most Americans live on credit. They take loans to funnel their expenses, whether it is to buy a house, a car, their education, or anything else. According to the Federal Reserve Bank of New York, consumer debt hit a fresh record at the end of 2022 while delinquency rates rose for several types of loans. Hence, debt across all categories totaled $16.9 trillion, which is about 70% of U.S. GDP. This, therefore, makes the credit market one of the most profitable markets within financial markets.

When the central bank applies quantitative easing, financial institutions such as commercial banks, mortgage companies, and credit card companies become even more valuable because they have more money to lend to individuals, households, and organizations. Thus, individuals and households take riskier loans at low interest rates.

Middle-class households use consumer debt to support themselves and their lifestyles. The problem with consumer debt is that it is money borrowed to be spent on liabilities. Liabilities are anything a person or a company owes. When a consumer spends on liabilities, it means that that person is spending on something that won’t generate any revenue in return. For example, a car used for personal reasons is considered a depreciating asset, hence a liability, because its value declines as it is used, and it does not generate any revenue in return.

Debt derives its value from the real value of future resources. This means that to pay back a debt, one must extract value from future resources, and transfer that extracted value into the use of present resources. This then makes the use of future resources less valuable since a portion of their real value is gone. Thus, when a consumer gets his paycheck and must make his/her monthly payments related to whatever debt he/she owes, the remainder of the money left after making these payments is much less than what it would have been if there was no loan payment to make.

Consumer debt is problematic for several reasons. First, it often has high-interest rates, which can make it difficult to pay off the principal balance. This can lead to a cycle of debt, where people borrow more money to pay off their existing debt. Second, if people can't afford to make their monthly payments, they may fall behind on their debt. This can damage their credit score and make it difficult to get loans in the future. In some cases, it can even lead to bankruptcy. Third, consumer debt can have a serious effect on people’s mental health. Indeed, the stress of being in debt can take a toll on your mental health. People who are struggling with debt may experience anxiety, depression, and sleep problems.

Those who use debt to increase their wealth then move from the middle-income bracket to upper-income brackets, and those who can’t pay back their loans become underwater and they move from middle-class income brackets to lower-income brackets. Those who move into upper-income brackets usually use debt as an investment instrument to increase their wealth by investing in a set of securities.

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