THE BEAR'S LAIR The collapse of consumer spending
By Martin Hutchinson
The gross domestic product and employment figures released last Thursday and
Friday appeared at first sight to show a US economy that had returned to a
measure of stability. However, when examined more closely, they painted a much
darker picture, of an economy in which a sharp decline in retail spending is
likely to cause substantial overall economic contraction over the next several
quarters.
Second quarter gross domestic product (GDP), announced on Thursday, came in at
1.9% growth, which at first sight is an un-alarming number. However, it is
questionable both what quarterly GDP measures and whether it measures it
accurately. In 2006-08, according to this month's figures, three quarters of
sub-par
growth averaging 0.8% (recessionary, given 1% US population growth) were
followed by two quarters of enthusiastic 4.8% growth, which have now been
followed by another three quarters of growth averaging 0.8%. During the two
quarters of enthusiastic expansion in mid-2007, the largest credit crisis in
decades exploded. Certainly, nobody noticed this expansion at the time.
The reality is that the current expansion in GDP is caused almost entirely by
the inexorable expansion of government and a modest rebound of exports, led by
the weak dollar, from their previous abysmally low levels. Real federal
government consumption rose 6.7% during the quarter and real exports rose 9.2%.
Meanwhile, personal consumption rose only 1.5% in real terms, even though real
personal income rose over 4%, all of which was accounted for by the US$150
billion tax rebates, the great bulk of which arrived during the quarter.
The unemployment figure announced on Friday was equally pregnant with meaning.
The market welcomed it, as the job total declined only 51,000, but the real
situation was demonstrated by the unemployment rate, which rose to 5.7%. While
a job loss rate of 50,000-70,000 per month is not extreme, the fact remains
that this is the seventh successive month of such declines, during which the
employment total has risen by over 500,000, in a country where because of
population growth around 150,000 jobs should be created each month to keep the
employment percentage stable.
Not every factor in the US economy is negative. House prices nationwide are
probably now nearer their bottom than their peak, helped by the huge amounts of
money the Fed has pumped into the system. The Case-Shiller house price index
announced last week was treated by the market as yet another negative, but in
fact the monthly rate of decline lessened, suggesting that the "second
derivative" of house prices had turned positive. With prices already down over
20% nationwide, it seems reasonable to assume that we are more than halfway to
the bottom - a total drop of 40% would not be consistent with gradually rising
nominal incomes and continued low interest rates.
Of course, once interest rates are raised to a more reasonable level, say 2-3%
above the current inflation rate of about 7%, house prices will undergo a
further decline, but that will be cushioned by the inflation itself.
Nevertheless, the drag on the economy that housing has formed will lessen over
the next year, if only because housing has become a smaller share of output.
The more difficult assessment is how much construction redundancy has still to
be shaken out. Most of the larger homebuilding companies accumulated so much
fat in the good years that they are not yet in true financial difficulty.
Furthermore, the commercial building sector was strong until the end of last
year and so has as yet lost relatively few jobs. Hence, while 550,000 jobs have
been lost in the construction sector since the peak, we are likely still to be
closer to the top than the bottom in terms of job losses, with multiple major
bankruptcies of construction companies and massive redundancies still to come.
Exports also will probably continue to be a positive factor in economic growth,
at least while interest rates remain low and the dollar weak. However, US
exports tend not to be very labor-intensive, so expansion in the export sector
does not produce much additional employment, at least relative to the decline
in construction employment. Moreover, the collapse of the Doha round of trade
talks suggests that the world is swinging towards protectionism, so that the
growth in trade as a percentage of world GDP that we have seen in the last
several decades will at least temporarily halt or even reverse.
Thus, while higher global interest rates and slower growth in the US and
worldwide are likely to continue narrowing the US payments deficit, it is not
at all clear that they will do so by increasing US exports rather than by
reducing imports. The export sector cannot therefore be relied upon for much in
the way of additional employment.
While the effect of the housing recession may in some respects lessen in the
months ahead, difficulties in the automobile industry seem likely to become
more severe. General Motors’ second-quarter loss, reported on Friday, of $11
per share is truly alarming for a company whose share price is currently only
$10. Ford and Chrysler are in similar difficulties; it would seem that none of
the US "Big Three" have sufficient resources to survive a recession lasting
beyond the end of 2009. Should the US-owned automobile industry declare
bankruptcy, it would doubtless be bailed out by the US taxpayer like everything
else, but the effect on business confidence would be severe. In any case, the
redundancies caused by even a partial closure of US automobile manufacturing
facilities would themselves add very substantially to unemployment, with older
workers being particularly badly affected.
There thus remain two vortices sucking the US economy into a pit of depression:
employment and retail spending. While output rises so sluggishly and all
sectors involved with real estate continue to shed jobs at a rapid rate, it
seems unlikely that the US can create significant jobs overall. Hence whether
or not there is an official "recession" by the eccentric GDP figures,
unemployment will continue to rise.
Since the peak unemployment rate was 6.3% in the 2001-02 recession, it is
almost certain that the unemployment rate this time will rise beyond that level
(unemployment is, after all, a lagging indicator of economic activity). The
peak in 1990-92 was 7.8%; a rise beyond that level is by no means out of the
question, although the peak unemployment rate in the 1980-82 recession of 10.8%
will probably remain unchallenged unless the US-owned automobile industry is
allowed to disappear altogether. Nevertheless even a rise in the unemployment
rate to 8%, historically a fairly mildly recessionary level, will cause a huge
amount of heartburn among a US working population that has seen nothing like it
in more than a generation.
Even more of a downdraft will be provided by retail sales. These have been weak
even in a period when they have been subsidized by Uncle Sam. Uncle Sam's
wallet is now empty (or, more properly, his banks have taken to making
incessant whining phonecalls during mealtimes). Hence retail sales will be
exposed to the full force of the current economic situation, which for them is
dire indeed.
First, the decline in house prices and the tightening in lending standards have
eliminated for homeowners the possibility of a mortgage refinancing that can be
spent on goodies. The decline in home sales has also removed the desire for
monstrous and unnecessary home improvement projects, to the great detriment of
Home Depot and the like.
Second, the decline in home values and stock market prices, and the lousy stock
market returns obtained since 2000 are beginning to demonstrate to the baby
boomers that they are grossly ill-prepared for retirement. This has been true
for a decade or more, but the specter of old age is looming ever closer as the
largest bulge cohorts near 60. All across America, aging baby boomers are
resolving to lead lives of austerity and saving, hopefully with more chance of
success than their diet resolutions.
Third, to the extent redundancies occur in declining industries such as
automobile manufacturing, they will be concentrated in the older cohort of
workers, who are much less prepared for them than were their depression-reared
parents a generation ago. The revival of export industries may offset this to
some extent for those blue-collar baby boomers who have managed to hang on to
jobs in the right manufacturing exporters.
Fourth, since returns on saving are so poor, the amounts that must be saved in
order to meet retirement or other goals will be substantially greater than
expected. Again, this will hit retail sales.
Finally, much of the retail sales ebullience of recent years derived from the
top 1% of income-earners, whose share of national income rose enormously during
the loose-money period since 1994. Since these people were earning far more
than they had ever expected, and saw no reason why their earnings should ever
decline, they saved very little, preferring instead to devote their resources
to overpriced homes, expensive toys and bling.
It now seems almost certain that their income share will revert over the next
few years to around its 1994 level, little more than half its level in 2006.
Over the last year, they have covered their "needs" by increasing debt; over
the years ahead their resources will of necessity be devoted to debt repayment
and saving, causing an icy winter in the luxury goods sectors of the economy.
The gradual increase in unemployment and decrease in real estate and equity
values will be important drags on the economy even while interest rates remain
at their current low levels. Needless to say, the resurgence in inflation to
which negative real interest rates are already leading will eventually force
interest rates to be raised, as I discussed two weeks ago. When that happens,
the unemployment effect will be significant, as over-borrowed private
equity-controlled companies will find themselves unable to survive.
Conversely, the retail sales effect may be somewhat mitigated, as consumers
find they can meet their savings goals more easily in an environment where they
are at last granted a positive real return on the amounts they save. Stock
market and real estate investments may still disappoint, but at least bank
deposits and short term investments will provide a real return much higher than
has been customary, restoring some equilibrium to the financial positions of
the US public.
While the market is already aware of the gradual increase in unemployment, it
has not yet taken into account the effect of the recession on retail sales.
Hence we can expect sharp reactions as the full extent of the retail downturn
is revealed. Retail sales figures, not GDP, interest rates or employment, are
now the economic numbers to watch.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-07 David W Tice & Associates.)
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