This morning I was reminiscing about the good old days of January of 2022 when the rumors first started. The “R” word seeped into traders’ minds as the Federal Reserve prepared to start battling inflation with interest rate hikes. The thought was that recession was imminent within the next six to twelve months.
Those recessionary fears were either misplaced or mistimed, and it is impossible to tell the difference until the present is converted to the past.
With the passage of time, we now know that the Federal Reserve would go on to raise its overnight target interest rate from 0% to 5.50% in a mere 16 months. If this trajectory would have been known in January 2022, economists would likely have predicted an unavoidable depression by now.
Yet, from a purely economic standpoint, our country has exceeded expectations by far. The biggest surprise has been the average American consumer’s can-spend attitude.
It is no secret that Americans are cumulatively horrible at deprivation. Driven by increasingly sophisticated attacks on their sensibilities by advertisers, we have minimal restraint when it comes to purchasing what we want when we want it regardless of the ramifications on our long-term financial well-being.
This passion for unbridled short-term satisfaction is entirely affordable when government subsidies are significant and interest rates are negligible. Driven by the deep-seated urge to maintain an unsustainable lifestyle, consumers have thus far ignored their dwindling bank accounts and surging credit card interest rates to keep feeling good about themselves.
This lifestyle leverage is manageable for a period of time as long as one leaves themselves a margin for error. With no margin for error, unexpected life events such as job loss, health challenges, or other missteps can create insurmountable financial setbacks.
The best margin for error to build into your financial life is living below your means. Be sure you have something left at the end of every month to set aside for future expected unexpecteds.
Adding a healthy savings account that can cover at least six months of vital living expenses creates an additional margin for error. Now you have the ability to pay for those expected unexpecteds with cash instead of debt.
Avoiding the monthly payment trap increases your margin for error further. Just because you can afford the monthly payment does not make it smart. It just means you are convincing yourself (with the help of eager sellers who wish to convert your money into their money) to buy something you cannot afford or do not need with less initial pain. It is a fateful trap whose reach is rapidly expanding. If you do not have the ability to pay for it in cash, take a step back and reassess whether this purchase is truly necessary for your or your family’s survival.
After being so strong for so long, it appears that American consumers are starting to exhaust what little margin for error they had initially. Recent economic reports on consumer confidence, credit card debt, and auto loan defaults indicate a bit of trouble brewing for the previously undiscourageable consumer. Anecdotally, complaints about high prices – from fast food to car insurance — are top of mind.
If the American consumer has truly stretched themselves beyond their minimal initial margin for error, we could certainly see the corresponding economic slowdown that has been anticipated since January 2022.
While this could be viewed as a negative, it could also be a blessing that permits inflation to fall while creating opportunities for those with disciplined long-term investment plans.
Quote of the week: Charlie Munger: “It’s good to learn from your mistakes. It’s better to learn from other people’s mistakes.”
Photo Credit: iStock #1510590524 | Credit: ariya j
