Plastic surgery

By Irwin Kellner, MarketWatch

PORT WASHINGTON, N.Y. (MarketWatch) -- Consumers are pruning their debts so quickly, you would think that they must be cutting their credit cards in two.

Chalk up another reason to expect a double-dip. People are not only borrowing less, they are actually paying off some of their debts.

According to the Federal Reserve, total household credit outstanding has declined for seven quarters in a row. Such a prolonged period of debt reduction is virtually unparalleled in the postwar era.

Since the end of the Second World War, the usual thing was for consumer credit to rise. In the 1940s, debt would rise about as fast as household incomes, leveling off at around 50% of annual earnings.

Starting in the 1950s, with the introduction of credit cards, household debt began to rise faster than incomes. They passed 100% of annual incomes in the 1980s and peaked at close to 135% a couple of years ago.

But the recession that began at the end of 2007 did a number on employment and incomes. At the same time, the financial meltdown of 2008 caused the banks to cut back on loans of all types, but especially those made to consumers.

As a consequence, consumers began to borrow less and credit outstanding began to fall. At the same time, people began to rebuild their savings accounts, which they had virtually emptied during the bubble years.

This de-leveraging has begun to take its toll on consumer spending. In the most recent two months, retail sales declined after rising (tepidly) during the previous seven months.

As they buy less, retailers are forced to reduce selling prices and run special sales in order to move merchandise. The more prices fall, the more discounts people demand; they tend to hold off buying until they believe that tags have reached rock-bottom.

Those who deny that we are headed for (or are in) a double-dip believe that the contraction of household debt over the past two years has reached a level that has made people comfortable enough to go out and spend.

Since retail sales make up one-half of consumers' spending, and thus, one-third of the gross domestic product, it would be difficult for the economy to expand in the absence of a rise in these outlays.

But these optimists overlook the fact that besides hurting from the drop in employment, most households are also suffering from a decline in their wealth because of the drop in prices of homes and their investments.

In addition, debt-to-incomes levels remain historically high. They may have to fall for another year or more before people feel comfortable enough to resume their regular visits to the mall.

This leaves business with lots of unsold goods that must be whittled down. The process of doing this will hurt prospects for growth, just as rebuilding depleted stocks caused the economy to pull out of its power dive a year ago.

One way or another, people (and businesses) have reached a new stage -- one that virtually ensures a double-dip. They are hunkering down and are likely to drag the economy with them for some time to come.

Irwin Kellner is MarketWatch's chief economist.

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