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Will A Debt Diet Get The Economy Back In Shape?

By Nico Isaac
Thu, 01 Jul 2010 12:15:00 ET
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The other day I made a startling discovery while attending a friend's barbeque. I opened the freezer door and there, next to a box of assorted popsicles, were three credit cards -- sealed within a solid brick of ice. That was my friend's way of dealing with his debt problems.
Sound familiar? Well, according to a recent Newsweek cover story, America has gone on a serious "All-Cash Diet." This financing-free, fiscally conservative movement is already reshaping economic policies and consumer practices in dramatic ways -- all with one main goal: To reverse the onset of Type 2 Debt-abetes brought about by a decades-long borrowing binge.
All around, the order of the day is restraint. And, as the following statistics show, from individuals to investors alike, personal and private d-arrears are shrinking fast:
  • In 2009, the banking system notched the largest decline in loans in the history of the Federal Deposit Insurance Corporation (est. 1933). The amount of outstanding commercial and industrial loans declined 19% since the fall of 2008.
  • Meanwhile, on June 30 the House of Representatives approved the "most mammoth legislative" banking reform bill since the Great Depression; its main objective is to "install new capital and leverage limits" for too-big-to-fail institutions.
  • As for individuals: June 2010 saw a 24% increase in the number of people paying down their credit card balance, while recent Federal Reserve figures show a $113 billion decrease in the average amount of consumer debt from 2009.
The mainstream majority's faith in the debt diet to get the US economy back in shape is self-evident. In the upbeat words of the Newsweek story, "Financial engineering has given way to business engineering. The greater use of cash is a basis for a more stable, more rational financial system."
So, are they right?
Well, before we can answer that, we must first acknowledge the impeccable timing of the dramatic drop in the public's appetite for debt. In his business bestseller Conquer the Crash (now in 2nd edition), Elliott Wave International's president Robert Prechter made a forecast for this exact scenario via the following insight:
"The psychological aspect [of the societal buildup of the extension of credit] can not be overstated. When the social mood trend changes from optimism to pessimism, debtors, producers and consumers change their primary orientation from expansion to conservation. As creditors become more conservative, they slow their lending. As debtors become more conservative, they borrow less or not at all. As consumers become more conservative, they save more and spend less..."
Recent data suggest that's exactly what's happening: Instead of re-investing their cash, both businesses and individuals alike are holding back. On top of that, the May 2010 Elliott Wave Financial Forecast presents this compelling close-up of the percentage of unemployed without jobs for more than 27 weeks.
In EWFF's own words: "The 40+% total is by far the highest since the data was initiated in 1948. This chart captures the bedrock vulnerability of consumers."
From excess to discipline; consumption to control -- the historic sea change is underway. Stay out in front of the biggest developments via a risk-free Financial Forecast Service subscription.

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