Our Human Nature is Beyond a Response to Stimulus
An emerging problem facing many people today is that the price of a product that is presented to the consumer does not accurately represent the consumers’ real costs. I would challenge any person to walk into any new car dealership and figure out what will be the real price to be paid or the real cost incurred based on the listed price on the sticker, the advertized price with or without rebates, unknown “APR’s”, dealer price, employee price, and whatever information you can gather from the internet. I know that agreeing on a price, weather cash or credit, can take hours. And when I am finished negotiating and driving away in my new car I wonder if what I agreed to pay was really fair or did I hurt myself by paying too much? I wish I knew!
The finance charges of buying anything using credit must be added to the initial purchase price to know its real cost. The cost of buying anything on credit is hidden or disguised from unaware or ignorant people. The price held in a person’s mind or seen on the sticker certainly does not equal the total payments made over time. It is probable that three different people with three different credit histories will all agree to purchase an identical car at the same price and all three people will incur very different real costs to their lives. Three examples of financing $20,000.00 of the purchase price of identical cars over a period of five years for our three different people of various credit histories could be:
1. Excellent credit…. $20,000.00 at 3% interest over five years is 60 payments of $359.37 totaling $21,562.46.
2. Fair credit…………..$20,000.00 at 8% interest over five years is 60 payments of $405.53 totaling $24,331.62.
3. Poor credit…………$20,000.00 at 15% interest over five years is 60 payments of $475.80 totaling $28,547.91.
These examples are not made to pass any moral judgments’ on borrower or lender. The examples exhibit the difference between the same $20,000.00 price in each person’s mind and the three different total costs of $21,562.46, $24,331.62 and $28,547.91 incurred by each individual respectively. We all know that the real cost of buying an identical car is different for different people in different circumstances. Fair or not, differing real costs for differing consumers is the reality people experience. What is problematic is that many people confuse the price they have in their mind with the total cost that is actually paid over time. The total cost paid over time is reality while the price they have in mind is not. The $20,000.00 price in mind is believed to represent each individuals’ real cost when in the real world each individual incurs, respectively, the different real costs of $21,562.46, $24,331.62 and $28,547.91. What is believed to be real (as price) is not real (as is the total cost over time); the idea that the price accurately represents the total cost when credit is used is mistaken.
Imagine being a person of fair credit, believing he is paying $20,000.00 for a car, and in reality paying $24,331.62 for that car over time. How many times can the $4331.62 mistake be repeated? I do not know. You might say that ‘people really do know how much they are paying or at least they should know’. That may be true: but, the first point is that their purchasing behavior was based on the belief that the $20,000.00 price held in mind was the real price they are paying; and, the second point is that the idea of the $24,331.62 total cost, if it came to mind at all, came to mind generally as an afterthought which had little or no influence on their purchasing behavior.
I wish to drive this point home just a bit further. Imagine being the home owner when I ask you how much you paid for your house. Will your answer be the buyer/seller negotiated price (of say $200,000.00)? Or will you answer with the total cost calculated over time (of say $20,000.00 down payment, $180,000.00 mortgage over 30 years at 4.5% with monthly payments of $912.03 for a total cost of $348,333.52)? Most people say $200,000.00. This may be self deception on a mass scale; a deception that for some people makes huge differences in their standard of living. A home buyer with less down payment or worse credit might agree to this: $0.00 down payment, $200,000.00 mortgage over 30 years at 5.5% with monthly payments of $1135.58 for a total cost of $408,806.90. While there is a $60,473.38 total cost difference facing the different buyers, I will bet, most home buyers will say and believe and behave as though they paid $200,000.00 for their house.
Reality will not be ignored long before it demands to be recognized, and in the real world price does not always equal cost. If I define price as the number that is held in one’s head it will equal the physical number printed on the products sticker or it will equal an amount negotiated (that is often to be financed) between buyer and seller. Within a cash transaction price will equal the cash exchanged for the product or service and most importantly it will accurately reflect an immediate real cost. Within a credit transaction price will not reflect a real cost and thinking that it does can be a costly mistake. Reality for the cash purchaser is different from the reality of the credit purchaser.
Real costs involving credit are the total cost calculated as price plus interest paid over time. If I define cost as what will be actually paid then that number must be calculated and kept in mind if an accurate representation of reality is to influence a purchaser’s behavior. Believing that price equals cost does not make it so. At Wall Mart or at a grocery store the cash, check, or amount debited, is equal to the price of the goods purchased. When those same goods are purchased using a credit card the price printed at the bottom of the receipt will not represent the real cost of the goods for that buyer. It is the knowing and respecting of this fact that price easily misrepresents cost that will influence behavior. Masses of people behave in a purchasing manner that suggests that they do not know or respect these truths. For many buyers using credit the purchase price held in mind never represents their real costs; their real costs are actually out of mind. What they think is the price they are paying is a fantasy held only in their imagination; reality is actually a rising total debt because real things purchased on credit have a higher real cost than at first appears.
As simple and as obvious as this seems it is my contention is that it is the ignorance (by many people, businesses, and governments) of this real difference between that price which we picture in our mind and that total cost which we really pay over time that is at the heart our present economic crisis today.
It is often hard for many people to believe how big their debt is when they believe they didn’t really spend that much. And perhaps they didn’t spend that much, but for what they did buy they ultimately paid a high price. Most people that buy on credit behave as though the price they are paying for the good is what it costs them. In reality it costs far more. With regard to a credit purchase a person’s belief in mind could hold that the price is low enough to represent the thing as being worth buying; whereas, for the person mindful of the real cost that cost is too high to represent the thing as being worth buying. A person’s behavior is based on what they believe to be real; that is, they see reality as the sticker price that is easily held in their head or they see reality as the total cost paid over time. In the first case, when only mindful of price, the price (which does not equal real cost) appears low and they purchase immediately. In the second case, when mindful of the real cost, the real cost (which does not equal price) appears high and they put off the purchase.
Behavior based on mistaking the price for cost has profound ramifications for economic systems. Credit purchases based on this mistake will artificially stimulates a demand for the goods and services purchased because the price appears lower than its real cost. Businesses, however, will actually produce enough goods to meet this propped up demand for all the consumers that confuse or ignore the difference between the idea of a low purchase price and the real cost involving credit. Behavior of persons mindfully considering the difference between a cash price and the higher real costs incurred by using credit will adjust demand downward with regard to any good or service requiring the use of that credit.
Our present economic crisis is based in the fact that a great number of people are being forced to becoming aware of a need to consider this price/cost difference. Their behavior, which led to an over extension of debt and an overconsumption of goods, is a direct result of not considering this difference. Their changing behavior, which is now withdrawing from the use of credit, is based in having in mind the real cost of using credit. When the real cost of credit is kept in mind then demand for goods and services will no longer be artificially stimulated. Demand will come down to a level based on the real costs instead of the non-credit cash price greatly impacting businesses that use credit to help generate profits.
Businesses that generate profits by financing the purchases of their goods or services are now facing difficulties proportionate to their use of that financing for those profits. It is conceivable that some companies switched to generating their profits through financing because price competition for cash purchases drove profits very low. It then became easier to compete for profits based on financing because that financing hid the real costs from most consumers. Automobile companies, retailers such as Sears, conglomerates like GE and any kind of business that has become dependent on their own financing of purchasers to generate profits has contributed to the misleading relationship between price and cost by presenting to consumers prices that seem low when in reality the financed cost is high. When using financing to generate profit the price tag on a good or service will tend to be lower (to entice people into using credit) than what would be necessary to generate that same profit without using financing. It is probable that businesses highly dependent on profits through financing will even discourage cash purchases because selling for cash at the list price will produce little or no profit at all.
Ultimately businesses that financed the purchasing of their own products built a capacity to produce enough goods to supply a market where people behaved in a manner that mistakenly accepted the price as equivalent to the financed cost. Once consumers realize their mistake they will withdraw demand leading not only to an oversupply of goods but also to an over capacity to produce them (the basis of deflation). Thus if the use of credit decreases so will the ability to generate enough profit to stay in business. And if credit tightens an initial oversupply of goods and services will face deflationary pressures (of too many goods needing to attract fewer available dollars) leading to falling prices. Once the original oversupply is consumed the list price on goods will have to rise to a point that will make up for the loss of profit that was generated by financing purchasers if the business is to continue operating. Of course the higher list price will also discourage demand.
Retail businesses (that are not operated as finance companies) generate their profits based on what is paid for the product at the moment the transaction occurs. Whether a good is paid for using cash, check, or credit makes little difference to the retailer at the time of purchase; because, for the retailer the price on the sticker accurately represents what is received in payment. From the retailers point of view the sticker price represents the real cost to the consumer. Inventory is ordered and manufacturers produce goods for a market based on that retail price; but, that retail price that seems real to the retailer is not the same as the real cost to the buyer using credit.
The consuming of products purchased on credit has long term effects on retailers and their customers. From the point of view of the retailer corporate profits should be able to be estimated by taking the price paid by the consumer, minus the businesses costs involving the product incurred, multiplied by the number of units sold. While that will work for past purchases it will not work well for future projections. In reality, the cost of credit is incurred in the future and this has two results: first, future demand will be less than current demand; and second, the real cost to consumers is much higher than the price the retailer receives. Future profits must adjust downward with a cannibalizing of demand.
The lender of credit becomes the collector of the difference between the price paid to the retailer and the real cost to the consumer; the retailer collects the sticker price and the consumer pays to the lender a higher real cost over time. By extending credit for purchases today the lender enables an increased stimulation of demand for today. By collecting payments of interest and principal in the future on today’s purchases the lender will stimulate a decrease in future demand by absorbing the consumer’s future purchasing power. For the unaware retailer or consumer the lender of credit is, in reality, collecting a sacrificial cost from both the retailer (sacrificing future demand) and the consumer (sacrificing future purchasing power); and, both retailer and consumer let it happen because of either ignorance or the convenience of having one bird in the hand rather than having two birds in the bush. Both the consumer and the retailer, when dependent on credit to complete the transaction are related to the lender of credit as addicts are related to their pusher. The lender, who is extending credit to facilitate today’s exchange between buyers and sellers, when those buyers and sellers are blind to the real costs of purchasing things, is no longer profiting by performing the service of assessing practicality and risk; but, the lender is profiting from both purchaser (in lessoning future purchasing power) and seller (in lessoning future demand) by supplying the convenience of immediate gratification to anybody ignorant of real cost assessment.
Yes, I am pointing fingers at the banks issuing credit to ignorant consumers! I am pointing fingers at payday loan companies serving desperate people seeking loans at loan shark rates! I wonder, what would happen to people if banks would issue enough credit to people that they might have trouble paying it back? If I was a bank, I would like to keep borrowers just under that troubled threshold. If I was a bank I would be interested to know what profits I could generate if, as a bank, I were to raise the interest rate on my customers from 10% to 20% or even 29%. I might even justify the rate increase based on a late payment; I might even use the post office to help generate some late payments by mailing out payment notices near do dates and requiring the payment to be mailed to the opposite coast. I might even raise fees on those late payments. Another thing I might try, if I were a bank, would be to entice credit users from my competitors to transfer their loan balance to my bank by promising an absurdly low interest rate of 0%; I will bet that at the first late payment the interest rate could be raised to 25% -- 0% to 25% in a heartbeat – what a good deal for bank profitability.
Hmmm… if we, as bankers, could only keep people under that painful threshold of not being able to make their monthly payments: Hmmm… if we cannot then the huge interest rates we are charging will have to make up for the amount of people defaulting on their debt: Hmmm… if that does not work perhaps we could get congress to make it harder for people to declare bankruptcy. How profitable can we banks be and what might be the overall consequences?
Hmmm… if we could only get these people out of debt we bet they would thank us and feel relieved: Hmmm… if we could only encourage the debtors to exchange some of their short term debt (such as credit card or auto loan debt) for the equity that is in the home; in this case expensive short term debt will be exchanged for cheaper long term debt. We realize that it would be like taking out a 30 year loan on a car that may only last about 10 years and we realize it would not be a good habit to establish; but, people need relief from their pain now and they deserve a vacation from all their debt. Perhaps people will thank us bankers for bailing them out of their troubles.
What must it be like to have $10,000.00 in credit card debt? At 10% the cost of servicing that debt for one year is $1,000.00. At 20% the cost would be $2,000.00. And, at 29% the cost would be $2900.00. For those consumers habitually in $10,000.00 of debt, at 29%, it means that the goods they purchase every year for $10,000.00 really costs them $12,900.00. It also means that the $2,900.00 of interest payments goes to the provider of finance and not to the profits of retailers or producers; in fact, the $2,900.00 cannot go to purchasing any good at all. In this example, it means that $2,900.00 of the total cost of $12,900.00 goes to the production of no-thing beyond convenience. In this example, it means that $2,900.00 must be subtracted from future purchasing power. In this example, it means that the real cost of goods to consumers that are habitually in debt is very high. It also means that in saving this $2,900.00 there is real hope.
There is hope that once people become mindful of and as long as they stay mindful of the cost of credit their behavior will be modified toward less demand with regard to the real cost of things used. Our present mindfulness of the high cost of credit, whether caused by job loss, out of pocket medical expenses, a credit overextension that can no longer be refinanced, or the actual pains of bankruptcy, will encourage a behavior toward increasing savings. Increasing savings or bankruptcy are the only things that will get people out of at least short term and high cost debt. And pain is the encouraging factor in keeping people mindful of their real circumstances.
Once people are out of debt and as long as they stay mindful of the real costs of things, then the real benefits of working through the pain can materialize. Those benefits will ultimately be a real increase in disposable income of $2,900.00 for the future out of debt person in the above example. That amounts to an increase in disposable income that dwarfs any stimulus check sent to consumers by the federal government last year or coming from the government in 2009. Not only that, by saving, consumers are actually behaving in a caring manner toward themselves. And, that $2,900.00 saved may eventually go towards purchasing a future good or service instead of future interest payments. That could lead to more employment of people that actually produce things that will be used. But, please note, this real kind of recovery can only be achieved by working through the pain. Giving and taking pills to deaden the pain will keep out of mind the things needed to be held in mind if behavior is to change.
As human beings we do not respond to stimuli in the same manner as plants or animals. All organic life responds in a manner of moving toward or away from stimuli. Human beings do not have to respond in the same way as organic beings because we can respond through knowledge of the thing that is stimulating us. It is through thinking and feeling things that are outside us that we get to know them and our place in the world. Things that are outside of us stimulate us into thinking and feeling about them. It is for this reason that what we think and feel about any thing always has to be checked out in the real world. Are we thinking correctly about things? Are we feeling appropriately? Answers to these questions are revealed only through activities we undertake. If we do not get the results we expected by our activities then our thoughts about how something could be accomplished are wrong or our motive to act in the direction we felt to be right is wrong or both our thinking and feeling are wrong. In any case we had better stop what we are doing and reflect. Was what we were thinking and feeling about things accurately telling us something about the real world outside of us or was it really telling us about something inside ourselves? Knowing the difference is what allows us to act as human beings and not just respond to stimuli like plants and animals. Getting to know the world outsides us and responding to it as it really is distinguishes us as human beings. Generally, in getting to know the real world we will sometimes experience pain. Pain is often a sign that we have been moving in the wrong direction. Pain generally stimulates people to wake up and reconsider their relations to the world. Pain says pay attention. Anesthesia for the pain is no cure.
Even the granting of easy credit to help sell the initial over supply of goods left in the marketplace will not place the now known high cost of credit back in the bottle. People are now leery of using credit because of the pain they are feeling; for, it is this pain that is keeping credit’s real cost in mind. Since the real cost of credit is better understood by the consumer the businesses that have supplied the goods and services based on the use of that credit will have to scale back production and they will also have to figure out how to generate profits on goods that are purchased at or near a cash price because those goods that need financing will be purchased by pained consumers more fully aware of the real higher cost of using credit.
Credit has no need to disappear. Goods will come to an end of their useful life and need to be replaced. Big ticket items will still need to be financed. And people will be educated by pain as to what they have been doing to themselves by ignoring reality. Like it or not, many people’s idea of how they would like reality to be is not mirroring how reality actually is. A necessary process of disillusionment is affecting everyday life. It is part of a process of getting healthy. What people are coming to terms with is that our present standard of living is being borrowed from our future standard of living. The consumer, in withdrawing from overdependence on credit, is showing a mindfulness of the problem. To believe that the consumer should do more of what is causing them pain by encouraging the further use of credit (by making it cheaper to borrow) is insanity. Saving is an act directed toward the future. It is and act directed at taking care of ourselves over time. And it is about time that the idea of participating in our own care better take root in our minds if it is to have any hope in changing our behavior in our future.
Businesses and governments do not know how to respond to the consumer’s new mind. Businesses and government officials are crying for more stimuli, either through greater government spending (most Democrats) or through decreases in taxes (most Republicans). In begging for the reestablishment of old and blind habits businesses and government desire the dissociation of price in mind from real cost because it is the traditional way things have been done. If they could only eliminate the pain then the consumer’s mind would seem at peace yet stay asleep to reality. But the consumer is awakening to the real problems of the cost of doing things in our habitual manner. And reality is forcing us to stop and reflect on how we are doing things. Reality will painfully stand in our way when we are doing things wrong. Hopefully we can get to know things as they really are and behave accordingly as the human beings we really are.
Maury Garvey, 2/25/09.
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