Don't Expect a Consumer-Led Recovery
This article is a joint article between Bonddad and Invictus at Blah3.
When economist David Rosenberg left Merrill Lynch to head back to his native Canada, he gave a nod to Bob Farrell's Ten Rules To Remember by penning his own. They are both keepers. Among the most important of the rules Rosie laid down, in my opinion, is #12: Get the US consumer right and everything else will take care of itself. The reason is fairly simple: The U.S. consumer has the biggest balance sheet on the planet. The U.S. consumer represents 70 percent of our GDP and about 18 percent of global GDP. As you review the charts below, it's also instructive to keep in mind Farrell's Rule #1: Markets tend to return to the mean over time. I'd suggest that reversion to the mean is not only market related, but applicable to the movements of most observable metrics (a basketball player who goes on an ice-cold 0-10 streak will at some point go 9-10 to get back to his long-term shooting percentage of 0.45).
We hear a lot of generalized talk about the U.S. consumer ("retail sales rose/fell more/less than consensus estimates"), but rarely do the media give us a good peek behind the curtain to see what's really going on. The best place to get that peek -- that look at what is really happening on America's balance sheet -- is Table B.100 of the Fed's Flow of Funds report, which was just released last week (through Q1 2009), from which most of what follows was derived.
While there seems to be a consensus that the worst of the recession is behind us, the focus has shifted as to what the recovery is going to look like. Various letters of the alphabet are invoked in that regard -- L, V, W, U, and so on -- to describe what our glide path will resemble in the months and quarters to come. Let's have a look at what we might reasonably expect.
The U.S. consumer has experienced a trauma to the balance sheet that is certainly unprecedented since the Great Depression. In the second quarter of 2007, the U.S. consumer had a collective net worth of some $64 trillion. Seven quarters later that number stands at roughly $50 trillion (-22%). Just looking at it from a year-over-year (not peak-to-trough) perspective is scary enough:
Another way to look at this is to analyze the value of various asset classes. Here is a graph of total non-profit and household mutual fund shares from the first quarter of 2008
And here is a graph of total household and non-profit real estate holdings
Notice how both major asset classes have dropped hard over the last year.
Over time, consumers tirelessly increased the portion of our GDP for which their consumption was responsible, ultimately breaching 70 percent in the very early part of this decade, and hovering there since:
So the question needs to be asked: To what extent can the consumer reasonably be expected to drive the economy (to trend or above-trend growth) going forward? The available evidence indicates the answer is probably "not so much."
Among the things we've done over the years is simply accumulate all manner of "stuff" (some no doubt necessary, much arguably not):
So the average U.S. household is sitting on roughly $37,000 worth of "stuff," and at this point is probably fairly well sated, particularly in view of our demographic situation (i.e. "boomers" past the age of peak consumption). The median age of a "boomer" is about 52, and most of his/her major purchases have probably already been made. Given recent declines in both the stock and real estate markets, it's likely the typical boomer is now scrambling to figure out how to get his/her retirement plans back on track, and it's highly unlikely that process is going to involve the purchase of yet more "stuff."
How'd we pay for it? Well, one way we paid for it was home equity extraction:
Here's another way of viewing the debt we've taken on, our debt-to-income ratio, which peaked a while back at about 133% and has since declined to about 128% (and likely headed lower):
Our debt as a percent of our assets has also been climbing as the numerator (debt) has grown and the denominator (assets) has shrunk:
Well, could the consumer get back on track through income growth? Not likely. First off, the simple fact of the matter is that "organic" income growth is not growth at all -- it's actually shrinking. In the last seven months we've seen employee compensation drop on a month over month basis:
Along with wages:
The only area where we've seen an increase is in transfer payments from the government:
Here's another way to look at the above information. Here's the year over year percentage change in personal income components over from the first quarter of 2007 to 2008
What we see above is government benefits is the only major component of Personal Income that has grown on a year-over-year basis. Dividends have been slashed (as corporations hoard cash) and interest income has gone down as the Fed moved short-term rates to zero. Both proprietors' income and private wages have similarly been in decline. Aside from the aforementioned declines in the stock market and real estate, another reason that even the "wealthy" are feeling the pinch is because their dividend and interest income has been declining. John D. Rockefeller -- who famously said, "Do you know the only thing that gives me pleasure? It's to see my dividends coming in," -- would not be impressed.
As consumers struggle to repair the mammoth hole blown in their balance sheet, the savings rate has risen -- and will no doubt be heading higher still:
(As an aside, for a variety of reasons, I would speculate that much of this saved money is going to be looking for an income-oriented home or used for debt reduction.)
Attitudes toward credit are changing, and it is highly unlikely further consumer consumption will be fueled by additional borrowing:
Looking at this from the longer term it appears the households have indeed brought in their borrowing. Here is a chart of total household debt outstanding at year end:
And as this chart shows, this trend started a few quarters ago:
(Flow of Funds, Table D.2)
In short, the U.S. consumer -- 70 percent of our GDP -- is not in a good place. Our experiment with leverage is over. I chuckle sometimes when I hear people talk about "getting banks to lend again." To the extent there are credit-worthy borrowers, it is becoming increasingly clear that even their appetite for debt is on a sharply downward trajectory.
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As a consumer I can assure you that my family will not be spending our way to “recovery”. Things have changed dramatically for my household. We are in the process of eliminating everything that is not essential. At first it felt uncomfortable, but now I find it liberating and addictive. Bye Bye cable (-$70/mo) see ya later landline (-$40/mo) guess we don’t need a second car or the insurance that goes along with it (-$35/mo). We do not go out to eat at all anymore, nor do we purchase things like chips and pop or processed food. We are going to start buying bulk meat from a local farm and are going to build a small laying chicken house. We have a fairly large and productive garden already in place. I have been buying clothes and other small items from yard sales. The ultimate goal here is to spend as little as possible. We are not behind on payments or straddled with credit card debt---we are just sick and tired of living on the edge and we are also sick and tired of being at the mercy of this economy. The less we depend on this sham of an economy, the better.
Consumer spending won’t lead the way. Housing won’t lead the way. Business investment won’t lead the way. The Government is borrowing and spending six billion dollars per day, the equivalent of 20,000,000 - $100,000 per year jobs, and we’re losing 100,000 jobs per week. These are not the numbers that lead to a robust recovery.
Eighteen months ago I noted that the Fed by pumping in money and the Treasury by enormous deficit spending were essentially mashing the pedal to the floorboard and the engine was still stalling. These tactics were standard recession fighting tools. I observed that this was not your standard recession. They continued and also threw in trillions to the miscreants of Wall Street to prop up their fraudulent institutions. Now the Fed is literally creating money out of thin air and throwing it to the hyenas in exchange for their worthless liar loan backed securities. The Treasury has doubled down on deficit spending and we’ve slowed the nose diving plunge to a hard crash landing on a cliff overlooking a bottomless chasm. We are still scraping along and if the economy is flat it’s an improvement.
Everyone says the worst is over. These are the same who missed it in the first place, and said it was contained as it worsened. The question now is will the printed money and debt be enough to kick start the engine or will it weigh us down and push us over the ledge?
"Everyone says the worst is over. "
Not everyone. It's just that people do not listen to those of us who keep saying that this is a long term structural problem and not one of those pork-belly cycles that come and go. It's a lot harder to think about the consequences of 30+ years of failed policies and stay upbeat than it is to imagine that all it takes is for the Dow and the Nasdaq to recover. But that, really, is more of a psychological than an economics problem.
Its common sense that any so-called recovery not based on significant job growth is illusion at best. We've all been through the jobless recovery ov 2002-4 and now know it for what it really was, the beginning of the new bubble in finance and real estate which has blown up in our face. The graphs and stories in this article are nice and reality centric. Our reality is simple, no real job growth will lead to no real recovery. This is a simple concept most clear thinking individuals not corrupted by corporate media propaganda find easy to understand. Too bad it gets stuffed under the carpet in DC.
As other posters have noted, if we don't get good paying jobs back in this country, there simply will be no recovery. If everyone makes $10 an hour ($25k seems to be the new "optimum" yearly wage), who is going to buy anything?
I haven't been buying anything except necessaries for over 2 years, but now, even though we can afford it, I don't feel like buying even bargains. The last two shopping trips I made, we went to Goodwill. I wanted plain woven shirts since they are often cooler in summer than even t-shirts. Instead of buying them at Walmart at $8-15 each, I found several shirts at the Goodwill that appeared brand new and only paid $10 total for 4!
My sister in Canada says she always goes to the resale shop before she looks anywhere else for clothes, pots&pans, etc. Resale shops, Walmart/Target, and ebay are going to be the biggest retail forces in the country for years to come.
I am getting a lot more than $10 an hour and you know what? I am still not buying a thing. I don't need more stuff. You can't build a nation on "needing to buy stuff".
What we need to do right now is to raise taxes to make sure people can buy LESS stuff, not more. And then we need to invest that tax income in social nets, medical insurance for everyone (so we don't have to treat them when they are sick beyond medical options), energy efficiency, new transportation infrastructure, you name it.
That's what we NEED to do. Of course, it's nowhere close to what we WANT to do (spend more money on stuff), so we'll just pass on the need part for another decade and we shall see how that goes.
Cool! So we are on the way of recovery! It's a looooong, arduous structural recovery, not the quick fix everyone is waiting for. I am very happy about that. For once Americans are changing their ways and that, over the long haul, will make this country better. It will take years for any of this stuff to kick in, of course, but hey, we had 30 years to mess it up, we'll just take another 30 years to clean it up.
:-)
I think we can do it in ten. ...So long as we can get those holdouts for the buggy whip industrial base to play ball fairly.
Granted, a lot of stuff was junk. But if you look at the prices of food, housing, oil, heat, electric, etc. over the past years, you will find that the majority was spent on ever increasing prices of necessities. The people who were truly wasting big loads of money on junk were those at the top who couldn't get enough of overpriced luxury items.
Overpriced, supersized, poorly built, environmentally insane housing is not a necessity. It's a choice. 12mpg cars are not a necessity but a choice. All meat diets are not a necessity but a choice. People made the wrong choices. Now reality is making the right ones for them.
This is an outstanding point that you are making! We live insanely gluttonous lives in this country and in many cases are easily lured by the BS in the mainstream media. All choices. I personally am glad that the new economic reality for Americans is putting them in the position of making choices that are actually healthier for their future development. As an example over two years ago I chose to move to a vegetarian, primarily raw diet! The benefits to my health alone have been amazing. I have lost over 25 lbs, rarely if ever do the couch potato thing in front of the TV, have literally stopped using my car since the beginning of soaring oil prices in 2007.
The greed of the oil barons got me angry enough to get off my butt just so the bastards wouldn't get a dime of my money. I walk to work everyday. I am fortunate enough to live approximately 1/2 mile from work. I have begun to grow my own food in an effort to stop eating the 3,000 mile salad. I live in a condo in the city, so I know from personal efforts that urban sustainability is possible. All my neighbors around me are now growing food as well.
The 'lets go back to nature' crowd sounds great, but in reality you will never get the majority of Americans to believe that should be their goal in life. It's great if people have extra money to pay double for organic products, super efficient hybrids and model energy efficient homes. Unfortunately that is not reality for Americans living on American wages.
The majority of people can now only afford a used car, a mid-size older house (or rental home) and the standard supermarket mass merchandised food, if they can even afford that.
The recession is not making 'the right choices for them'. It is now causing houses in neighborhoods to be destroyed just at the time when there are more homeless than ever. It is increasing the food and transportation costs, just at the time when they have no money to buy new cars or pay more for food.
As usual, Bonddad is the source of the most pertinent information. The one thing I would have liked him to factor into the equation is how much of the "stuff" American households have accumulated is of foreign origin. It has always struck me as a recipe for disaster that we have long since acquiesced in being a "service economy" (in other words, an economy which manufactures very little -- and now, after the virtual death of Detroit, even less) while the percentage of our national economy fueled by "consumer spending" has risen to over 70%. What this sounds like to me is that American households' "borrowed wealth" has been slowly funneled overseas -- most recently largely to China. So American consumers, using credit in one form or another, have being paying to turn China into a modern industrialized manufacturing economy, while our own manufacturing sector has dwindled perilously close to zero. Now ironically (ominously? paradoxically?) the Chinese hold a large share of our national (meaning governmental) debt. Where is any of this going?
My parents lived through the great depression, and because of that, were extremely thrifty and leery of stocks, etc. for their whole lives. They purchased a small house in a moderate neighborhood, paid it off, and lived well under their means with a great savings account (in CD's).
Now that my home has dropped 30% in value, and my retirement funds have taken a hit, I am likewise traumatized. I have all my funds in interest bearing accounts now. I am paying off my mortgage in 5 years instead of 30. I am spending very little, only what I can pay for as I go along. I plan to start shovelling the money into savings once my mortgage is paid for.
I will never again invest in stocks, mutual funds, speculative real estate, etc. I rarely use my credit cards, and if I do, I pay them off at the end of the month.
I no longer trust any financial advisor, mortgage broker, bank, credit card company, real estate broker, Republican, and if we don't get universal healthcare with a government option soon, any Democrat either.
I think this country is going into a long decline, though it will still be a better place to live than much of the world. I think it is too large, with too many powerful interest groups, to be effectively and fairly governed. The USA would be much better off spliting into multiple smaller countries, with a strong common market, but totally independent governments.
Cool. So suddenly you are doing everything a normal person with solid finance skills would have done anyway. Too bad that it took a "trauma" to get you there. One might think common sense would have done the trick.
Wow! Do you have to be so frackin mean! Even if it did take a trauma at least people are learning to listen to their common sense now.
Cool with it all but the last sentence or two. A better option would be to have the interest groups work together for the common good.
Hale, the US economy won't comeback without Consumer spending. As you pointed out 70% of GDP currently relies on Consumer Spending. Consumer Spending won't comeback without the creation of good paying jobs coming back. The US has been hemorrhaging good paying jobs for decades now, and what replaced wages for Consumers? Easy Credit - Credit Cards, Refinancing Mortgages, and Home Equity lines of credit allowed US Consumers to stay in the game. Those days are done. The mayhem that has been wrought on the US economy due to irresponsible use of credit has been felt on a visceral level by the American Consumer ... it was a crash course in credit aversion therapy, and I wouldn't be surprised if when Credit starts loosening up it will reveal a whole new spending psychology in the United States where those whose credit ratings haven't been destroyed during the downturn are going to be far less likely to spend like drunken sailors.
In short, to this point the "Recovery" seems to be relying heavily on accounting tricks rather than substantive actions to bring the situation back on track. That approach is only a stalling maneuver not a long term strategy of correction.
The United States needs good paying jobs - high tech, low tech, skilled, unskilled - to bring the US Consumer back online unless there is a new US Economy on the horizon that doesn't rely on American consumers to power 70% of it.
Saving money that would have otherwise been "invested" in bouncing castles for the kids is not an accounting trick. It's the most real, most honest and most helpful thing you can do to get your finances in order.
I agree, KTM, savings would be the best thing for Americans, but our economy demands spenders not savers, There are cultures which focus on saving, Chinese, Japanese, Indian, for instance, and that is why those cultures' consumers can't be counted on to pull us out of the Global Economic crisis.
The accounting trick I am referring is allowing Banks to keep their toxic assets off their balance sheets, and, moreover, to allow the Banks to decide the value of their worthless assets as well ... these are are accounting tricks that allow insolvent Banks to appear solvent. Add to that the way the Labor Department massages unemployment totals so as to make the employment situation look rosier than it is and you have a pretty good idea that a lot of denial is taking place, enabled by creative accounting.
Hi Hale,
Has ANY consumer gotten one dime of the stimulus funds? Just one thin one? Anywhere?
Guffaw. The Treasury sits empty. Until next April. Then they will empty it again.
To paraphrase our fearless leaders. Shut up. Sit down. Make sure you pay your taxes. Vote Schmote.
The stimulus wasn't meant for the consumer. We tried that last time, remember? We could as well have set that money on fire.
I think there are some highway projects that are already in progress which are the result of stim. funds.
If the folk who lay the pavement are not consumers, who is?
The consumer has had no increase in real wages for the past 30 years. To counteract this the family has taken multiple jobs, invested in Wall Street, invested in homes and then borrowed to unrealistic levels. All have eventually failed to solve their economic problems. They are now at the total end of their rope.
We are currently in another economic recession where all that happens is that government doles out huge amounts of corporate welfare to big corporations and the wealthy. At the same time they shove a few dollars of tax rebates to everyone else. Is this the way to treat they need to start the economic recovery? You don't need the corrupt financiers. The government can take them over and they can run more efficiently than they do now. Obama and his Wall Street Mob are still trying to implement failed trickle down economics. America is tired of 30 years of being trickled on!
If the next economic rise goes again to the big corporations and the wealthy, the average person will then revolt. Thirty years of wage stagnation and high real unemployment are now going to push Americans over the edge. They can understand a temporary downturn, but if things start to turnaround and they aren't part of it, watch out!
70% of GNP, yeah I've heard that, too, and thought same thing.
Especially when the consumer goods market is saturated with pure junk---some of it such rip-offs that they are sham products. When we were all so flush with money, there was the collective wisdom (?) to buy, try, and if it doesn't work, throw it away & get another one. No more.
My husband and I, frugal-natured as we are, slowed way down buying expensive new stuff years ago, for that very reason. It's been "used or nothing"---including cars.
I can hardly wait until quality returns to the marketplace.
Been needing a new mattress, lawn tractor, ceiling fan, dishwasher, medium-sized economy car that looks fairly nice, is comfortable, and doesn't stay in the shop...
What did recovery look like after the great depression?
Thirteen million soldiers (10% or the population) and everyone else working in defense plants.
weren't there any personal finance markers or did everyone just stop being broke all of the sudden.
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