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Guest Post: Dear Prudence, Won't You Come Out To Play?
Submitted courtesy of Contrary Investor
Dear Prudence, Won't You Come Out To Play?...For years now, we have been focused on the macro theme of the credit cycle in all its wonderful glory quite intently. For those reading our work over the years, you’d probably characterize it as focused “to a fault”. Again and again during the current decade we asked, is it a business cycle or a credit cycle? Of course after the events of the last few years, it sure seems that question has been answered in spades. At the moment, we believe our little credit cycle obsession is still the key focal point for what may lie ahead in terms of real economy and financial market outcomes. In this discussion we want to have a brief look at components of credit cycle character that as of today simply have no precedent over the last six decades of recorded Fed data. After looking at these data points, we want you to ask yourself, should we really be expecting a “typical” economic recovery? Secondly, we want to briefly have a look at historical patterns of consumption in prior recessionary cycles and what experience of the moment may be telling us relative to behavioral patterns of the past. Let’s get right to it.
When it comes to the macro credit and conjoined economic cycle, we suggest an important item to keep in mind is that historically; US economic recoveries of the last half-century have had similar “fingerprints”. Those being pent up demand for auto’s, housing and accelerating credit usage by the private sector. Every single one. They all look the same. But what we are seeing at the current time that is completely different than anything seen over the last six decades is net private sector credit contraction. The following chart could not be more clear on the issue. Remember, the private sector is made up of households and corporations (including the financial sector).
As you can see in the chart, even at the depths of any recession of the last half-century plus, year over year credit demand by the private sector has always been in positive territory. We’re currently breaking new ground. And this new ground begs the question, is Fed monetary policy impotent? Here we have the lowest Fed funds rate of a generation, and credit is contracting. Completely the opposite of what we have experienced in prior cycles. It could not be clearer. We are convinced this key fact is simply not getting the attention it deserves. Moreover, we need to remember that government stimulus efforts have been focused on reviving credit demand as of late. C4C (cash for clunker) and the tax credit for home buying was the sheep’s clothing used in an attempt to spark credit reacceleration. Crazily enough, despite the success of C4C in August, non-revolving (largely car loans) consumer credit balances actually shrank in the month! Not even C4C could offset the power of household balance sheet reconciliation. That’s a very loud message.
We know we are going to sound like pessimists and doom and gloomers with a few of these comments. We also know that we risk looking like idiots down the road by suggesting we buck the longstanding Street truism of “do not bet against the US consumer.” But every dog has its day, and we believe the consumer/household dog is barking, and loudly. Is it the end of the world? Of course not, but we believe changing patterns of behavior at the household level will have very meaningful consequence for investment outcomes ahead. As it applies to US households, two themes emerge from the numbers. First, we are currently in the beginning stages of a household balance sheet reconciliation cycle that we feel will be of a magnitude greater than anything we have seen in the post War era. Secondly, and we’re still early in this, household behavior regarding consumption is likewise in the midst of necessarily important change directly linked to the balance sheet reconciliation phenomenon. Lastly, we believe these two forces will be greater in magnitude than Wall Street may be discounting and will play out over a longer time period than the consensus now expects. Let’s get to the numbers and trends relative to historical precedent.
It should be no surprise to anyone that household debt outstanding fell again in 2Q (the latest Fed Flow of Funds data), making this now three quarters in a row of household net debt contraction. The important character fingerprint in the 2Q period being that debt contraction at the household level accelerated. Over the last three quarters through 2Q, US household debt balances have fallen 1.4%. In nominal dollars that’s a contraction of $199 billion. Admittedly pocket change set against the totality of household balance sheets, but from a thematic perspective, this contraction was a diversion from consumption. As we’ll see in a minute, consumption patterns in the current cycle are very different from prior cycles. Balance sheet reconciliation does not happen in isolation, and that should be key to our investment thinking ahead. The combo chart below chronicles close to six decades of the quarter over quarter change in household credit balances. The anomaly that is the past three quarters is clearly noticeable and nothing short of a dramatic contrast to experience of the current decade through middle 2008. Very quickly, although official Fed numbers are not yet available, anecdotal monthly data such as consumer credit suggests strongly the contraction in household credit balances continued in 3Q.
Certainly contributing to the net US private sector credit contraction highlighted above. If this is not the very picture of changing US consumer behavior, we just don’t know what is. Household sector credit contraction is a first in post War history.
And given yet still current levels of household debt relative to GDP, it seems a very easy bet that there is plenty more to come in this reconciliation cycle. Although it may sound a bit confusing to hear this, the household debt to GDP ratio depicted in the following chart has actually been quite healthy over the last few quarters. The ratio fell just a bit in the current quarter, but the positive is this ratio fell in a period where GDP also fell. That’s the picture of a household sector determined to restructure its balance sheet. Very healthy from a longer-term standpoint. And you probably thought you'd never see the day, right? In the spirit of non-linearity, that day has arrived.
As you can see above, the average for this ratio over close to the last six decades was 53%. There is no way we are going back to that level any time soon and we do not expect current cycle reconciliation to come even close to that number. But is it reasonable to expect that over a period of years with the combination of very modestly increasing GDP and continued net debt reduction by households that we approach a household debt to GDP ratio near where we began the current decade? Let’s say somewhere between 70-75%? We believe that’s more than reasonable. And that will change the face of the domestic economy and have important ramifications for consumption, and the investments represented by household consumption. This does not mean the world has to come to an end. It just means the world (the character of the US domestic economy) we have come to know over the past few decades, and especially this, is going to look different ahead. And that means we once again highlight the need for correct identification of active sector participation and avoidance. Retailers and the consumer discretionary sector have been riding a wave of macro liquidity, momentum and coveted out of the starting blocks high beta participation since March of this year. The character behavior of households as exemplified by the Flow Of Funds numbers suggests that may be one dangerous wave.
We’re going to step out of the Fed numbers for just a second and have a little walk down memory lane. Memory lane of personal consumption expenditures. As we see it, this is the natural counterpart to what we see playing out in the FOF numbers. If households are paying debt down, then something has to be given up for that balance sheet reconciliation decision. And the give up is consumption. Although you may not realize this, and this is clearly one of the key reasons why the long tenured Street truism suggests no one bet against the US consumer, personal consumption in nominal dollars has actually increased during each and every recession of the last six decades (at least). Each and every recession until the present, that is. The following table documents the increase in nominal personal consumption expenditures during each recession since 1960. Of course in the table we are assuming the current recession ended 6/09, given the perceptually positive 3Q GDP number.
It’s no wonder the Street does not want to bet against the US consumer, right? But it is also clear that the current cycle is very different. From December of 2007 until August of this year, point to point there has been no increase in US personal consumption levels. Completely the opposite of what history would suggest. Important enough to suggest secular change? We’re still early in the game so we’ll just have to see how it goes.
Okay, we know the numbers above are nominal. We also know that during the 1970’s and early 1980’s inflation was a major theme and certainly could have worked its wonderful way into these numbers. So the next table below looks at the personal spending numbers adjusted for inflation (using the CPI to reflect consumer prices). The numbers change a bit, but the current cycle still stands as the anomaly of weakness relative to the last half century.
Of course we also need to remember that ours has been the longest official recessionary period on record since the Depression. So everything you see in the tables above for prior cycles happened over a much more compressed space of time. In other words, we have had much more time in the current cycle for personal consumption to pick up, but it has not. Lastly, we believe it’s also important perspective to remember that in our current circumstances, households have been treated to some of the lowest interest rates of a lifetime and consumer product price weakness has been pronounced. Yet still zip in terms of consumption gains 19 months into official recession territory.
Because of the extraordinary length of the current recession, we also felt it important to quickly review the acceleration in personal consumption in post recessionary cycles since 1960. And that’s exactly what the following table reveals. Remember, some of these cycles saw official recession periods of less than one year. Important point being post every single recession on record since 1960, up went consumption. In fact, as is absolutely clear in the table, percentage growth in personal consumption proceeded in linear fashion each and every quarter, each and every period, over the 3,6,9, and 12 month periods following all recessions of the last half century. Like literal clockwork.
We concluded the table above with a few averages. The first is the average growth in personal consumption one year after all recession conclusions since 1960. The other covers only the post 1991 and post 2001 periods as these were considered “jobless recoveries”. Okay, what does this entire picture mean in dollars and cents and just how likely are US consumers to follow these historical patterns in the post recessionary period ahead? Well, at least as of September quarter end, the recession is now finally DOA as per the numbers from the Bureau of Economic Analysis (government reporting). In terms of headline or consensus thinking, this is where we are. So let’s mark June as the government’s version of the recession end period. As of the end of June, personal consumption expenditures stood at a SAAR (seasonally adjusted annual rate) of $10.05 trillion. So, using the historical averages and applying these numbers to current PCE levels, an 8.3% increase in nominal PCE over the next 12 months post recession implies a pick up in spending of $836 billion. Wow, that’s one big number.
Unfortunately, US wage and salary trends have been deteriorating since mid-2008. From the peak last year, annualized wages and salaries have fallen close to $300 billion since the third quarter of 2008. And remember, this is the exact period over which households have actually paid down debt. Very difficult to do in a deteriorating wage environment and very much a statement on a changed household outlook given their determination to reconcile balance sheets in a wage hostile environment.
So our question becomes, just how will consumers follow historical patterns and increase consumption in a post recession environment anywhere even near the magnitude of growth we have experienced historically? There is only one answer to that question and that is to increase debt. But this is exactly what consumers are not doing right now. Quite the opposite. To finance $800 billion of consumption in the twelve months ahead, total household debt would need to increase by 6.1%. Not a chance. We ask you, given these pretty darn clear facts of the moment, how could anyone be expecting a sustained “V” economic recovery in a consumption based US economy? We’re scratching our collective heads.
Very quickly, we did mention the jobless recovery periods of post 1991 and post 2001 recession environments. PCE grew much less in those initial post recession periods because job recovery ultimately took place years after official recession end. Not too hard to figure out why out of the starting gate consumption growth was sluggish. But you already know current consensus thinking is that the present will also be a “jobless recovery” period. So, for drill, if we were to experience “jobless recovery” average consumption growth over the next twelve months, we’d be looking at $455 billion in household consumption growth. If debt financed, household debt would have to accelerate 3.4%. Again, one tall order we believe has little to no chance of occurring.
We know that at this point you get the picture. Let us try to quickly summarize the key thematic issues here.
- For now, asset disposition is not an option for many US households. Remember, a huge chunk of current homeowners have little to no equity in their homes. So it follows that household balance sheet reconciliation will be driven primarily by income used to pay down debt, income that will not find its way into consumption.
- For boomers and their retirement expectations, reality has hit home. The need to save in the absence of asset inflation is here. The ability to do that, as well as pay down debt and consume means something in the equation has to give. Again, the logical give point is consumption. Below is a quick table we believe provides point blank perspective regarding demographics. The massive pre or post retirement boomer wave is moving beyond their consumption years and the numbers below tell us the demographic wave behind them is much smaller in size. Again, this says something about aggregate consumption levels ahead. A secular inflection point for the boomers in terms of their consumption habits? We suggest this should not be dismissed lightly.
- Although we only have one quarter of household net worth growth under our belts as of official Fed Flow of Funds 2Q period end numbers, the personal consumption numbers tell us the “wealth effect”, per se, from higher equity prices is simply not kicking in. Not this time. Just the opposite as households accelerated their balance sheet rationalization in 2Q. We suggest that the whole idea of the wealth effect ahead will be tested as a concept or perception. Again, in recent FOMC commentaries looking specifically at the Fed’s own recorded meeting minutes, they cited growth in equity values had offset a number of negatives at the household level. For now, it appears that the Fed is banking on the wealth effect with the liquidity driven equity levitation act to change consumer behavior. Is this a good assumption on the part of the Fed? Perhaps a key test of this theory lies literally dead ahead during the Holiday shopping season.
Hopefully in a bit of quick summation, consumers appear to have for now taken a vow of frugality. Whether by necessity or choice, prudence seems the order of the day. Does that mean consumers are not going to come out to play in the land of increased personal consumption any time soon? We think that’s the theme, along with continued household balance sheet reconciliation that must come. Is monetary policy now impotent in an environment where consumers choose not to borrow and spend? If so, that leaves increased fiscal policy as the lever ahead for the government, with all the consequences that come along with that. Finally, as we have said for years now, we believe investment success in the current period will necessarily be accomplished by active sector participation as well as active sector avoidance. Moreover, we believe it is critical to at least be open to the thinking that economic and financial market relationships we have grown to know and love over the past three to four decades are in the midst of meaningful change, perhaps secular change. As we see it, from a longer term standpoint linear thinking is death on Wall Street. If there was ever a time to think out of the proverbial box, so to speak, and leave the linear pathway, this is it. And for better or worse, so we will. The current unprecedented character of the credit cycle is simply forcing us to take this unbeaten path.
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Demographics = Destiny.
If you cannot understand the difference between fecundity and fertility (as a country) you are doomed. We are replacing and a push.
the difference is capacity versus ability. I think fecundity is the capacity to produce and fertility is the capacity to supply.
I doubt very much that the American middle-class (as we've known it post-War) is even replacing. In California, most births are to immigrants (as the largest growing sector). Nothing wrong with that -- hell, someone has to have babies -- but they won't be the next cohort of consumers the way the post-War boomers turned out to be; the economic acceleration and niche partitioning are just all wrong, not the least because we are no longer a producer nation at the top of our game. The next cohort will probably end up being wage slaves and join the declining middle class at the bottom rung of the economic ladder.
If you didn't make it already, you probably aren't going to make it. From here, the gap only widens.
cougar
Excellent post, tables & charts. Bravo. I do believe, this time is different. Group herd thinkers on wall street will march off the linear cliff together. ;)
This is what quality fundamental analysis is supposed to both look and read like. Great piece Contrary Investor !
Concur... this kind of honest analysis is exactly what primary degree wave 3s are built on. The illusion will evaporate, and the herd will move like never seen in our lifetime.
Find it
Cook it
Eat it
Sqworl
Great News - the savings rate declined from 4.9% to 3.3 from the second to the third quarter !! Who says the banks are not lending ?? Borrow Borrow Borrow Cause there is no Tomorrow (for any of us or our kids)!! Fed gets what it wants.. haha
I've always wrestled with the notion of sustained growth. Eventually our population will reach it's carrying capacity and growth will have to level off. Continued economic growth seems like a fantasy in the face of finite resources. Perhaps this latest change in consumer activity is the start of a more sustainable course. In the long run this is not doom and gloom at all, but a necessary slow down to prevent an all out collapse.
Clive Hamilton in "Growth Fetish" agrees with you (and so do I).Wall Street is lamenting the death of a very sick society.
Just watched Timmy on MTP say his biggest worry is "banks aren't taking enough risk".
He completely ducked the question on whether GS was taking to much risk knowing that if they got in to trouble the government would bail them out again.
I think David Gregory got his interviewing skill set from CNBC. It was basically a NBC sponsored 25 minute "Obama's economic policies saved the U.S from GD2".
I couldn't stand past the first 12 minutes. Dave was so determined in his questioning... jeebus. What a joke.
Remember, David Gregory is the guy that attempted to sell Governor Sanford of SC into coming on MTP because that show was a place where the governor could frame his position.
What else do we need to know?
Since Ronny Ray Guns the middle class (consumer) has not had a real wage increase. Once middle class realized the equity in their house was not real, they realized they were in debt big time. Watching the investment housees (banks) rob the taxpayer, the middle class sees the handwriting on the wall, we have reached the time in our countrys development where the rich are controlling the economy (and government) and the free market is a thing of the past. They watch helplessly as the government debases the currency and any hope for retirement goes down the drain. All they can do is hord money and they know that won't be enough, they are looking forward to a grim retirement. Don't count on the middle class for consumers, they have no money to spare.
The middle-class is rapidly imploding. Their last bastion of wealth was their homes, or else jobs in real estate. Both gone -- poof.
But I don't see how the wealthy are going to make it out alive, either. Without the middle-class and merchant class to suck blood from, the wealthy industrialists are reduced to the idle rich. And if you think those are the same thing, read up on the French Revolution and note how the idle rich were eaten.
cougar
Two anecdotal reports showing what appears to be an attitudinal change towards consumer debt:
1) Spend a few hours listening to Dave Ramsey's radio or tv shows from people drowning in consumer debt, and from people who have successfully paid off five and six figures of credit card debt.
2) This post from dshort.com, showing an SNL skit urging
debt avoidance which aired in 2006 at about the time that housing prices started gently nosing over.
http://dshort.com/articles/2009/SNL-case-shiller-indicator.html
whatever merit the main thesis of the article it was badly sullied with that nonsense about the end of the recession occurring in june....sounded like jim cramer declaring the end of the housing crsis on 6/30/2009...
I think the writers made their skepticism about the validity of that date plain. They were just taking the govt. at their "word," since it didn't really affect the overall validity of what they were arguing. The "automatic rebound" analysis (CNBC etc) proceeds from the logical fallacy of analogizing situations which are not analogous; we rebounded after recessions in the past with increased consumer spending - therefore we will this time. The "analysis" ignores our hollowed-out manufacturing base, the lack of wage increases, and now the nosedive in the "house as ATM" reality. In short, it's not analogous.
I read it the same way.
I thought the Contrary Investor was saying if the recession ended June 09 as you claim Bureau of Economic Analysis, where is your economic evidence in support?
I think it is very interesting that the BEA will not call recessions based on GDP alone any more... knowing the statistical unreliability and manipulation of those GDP numbers for political purposes (see John Williams at Shadow Gov't Stats)... think Bush I in 1992 during the election, Shrub in 2007-08 and now Mr. Change in Q3 2009...
Probably not a bad thought by the BEA.
+1
If you want to look where US is going, just look at a former middle class neighborhood in Detroit metro area, this is not an outlier exception to US prosperity but has been since the 70s they canary in the coal mine of US decline
Business made hay when they could save costs by reducing labor and still had a customer base to buy their products, thanks to increasing consumer debt...but eventually the gig is up when people essentially can't pay their min., interest-only payments on their debt anymore and start to default, adding asset deflation to the pre-exisitng problem to the loss of income/wages, as above charts show.
This piece of research is great, as it shows a jobless recovery is hardly a recovery. Even the unsuprassed "printing" of "housing dollars" (low interest rates, not loose lending standards)by the Fed in the mid 2000s and consequent housing boom did little to improve consumers contirbution to economy.
Contrary Investor, I'd be very interested in not just seeing the PCE growth after a recession but also in the boom periods.
How different was mid 2000s PCE compared to say mid to late 90s, mid 80s etc..
What did the housing mania do toe PCE growth in mid 2000s compared to other periods of prosperity. I think it would be very telling, and confirm your conclusions above.
Absolutely legitimate question, business cycle or credit cycle.
Does Bernank-ster know for sure?
Does Obama's crack economic geniuses know? Does Timmay and Fat Larry with thumbs strategically placed up rectums know?
That is the $64,000 billion dollar question… can you see the forest from the trees?
You make an interesting point by analyzing C4C and "Free $8k If You Buy Today!" as both debt expansion attempts. Most analysis has been C4C and the tax credit as pulling demand forward as a fix to a business cycle problem.
So your premise is the boys really do know what they are dealing with where most analysts think the boys are fighting the wrong problem. That could account for Fat Larry's "You don't what you are talking about because you are not as smart as I am…" routine.
As for "long tenured Street truism suggests no one bet against the US consumer"
The US Consumer, for 95% of them:
Stagnant real wages since 1973 (Correct? I have read many statistical measures…), consumption stimulated with easier consumer credit to replace real wage and income growth exploding debt burden, lay'em off in record numbers, jack up the interest rates on their credit access (29.9% anyone? Can't refinance at historically low rates when you are unemployed and 25% or all mortgages are underwater…), foreclose on'em, no job growth, no hiring, record numbers out of work…
So which ones of this 95% are going to spark growth in consumer spending, ye ole 70% of GDP?
Are the 5% who have the jobs and growing incomes going to replace the fall in consumption by the 95%, especially the 1% that have huge income growth?
The "Street" is now saying you can't bet against 1-3% of the population.
Can 1-3% support GDP growth since the 95% have been kicked squarely in the balls in income, wages, debt burden, employment, home value, 401k value… etc.?
Bet away "Street." You are betting with my subsidized tax money courtesy of Timmay, Fat Larry and Bernank-ster anyway. Or many of you on the "Street" would have been out of business as of September 08. You the "Street" would be in the unemployment lines along with less of the 95%. Bet away "Street."
As for all the economists predicting a V shaped recovery… this would not happen to be the same 80% of economists who never saw the housing bubble, Wall Street MBS fraud and derivatives that tanked the economy coming in the first place… would they? Clueless going in, clueless coming out or garbage in, garbage out.
I can tell you on the west coast in September 2008, the consensus of clueless cue ball economists was "this is just a subprime problem of irresponsible consumers who took out mortgages they could not afford." You were wrong cue ball economists, all parroting and politicking for SF Fed research grants or seats on the SF Fed board… I could name names… So should one believe the 80% of economic idiots who never saw it coming? I think not.
Population demographics… spot on. Ask the Japanese about that.
Will consumers throw off their vow of frugality?
You won't find that out until there are actual employment growth and then wage and income growth. Where is that going to come from? Construction, manufacturing like recessions previous to the 1990s? Or used car salesmen, used mortgage salesmen, used real estate salesmen, used mutual fund salesmen, used electronics salesmen like 2002 to until 2007?
"For now, it appears that the Fed is banking on the wealth effect with the liquidity driven equity levitation act to change consumer behavior. Is this a good assumption on the part of the Fed?"
Not only that, but Fat Larry has bet Obama's popularity numbers on rising equity prices, S&P, DJIA numbers going up to boost consumer confidence and convince the American public the recession is over and good times are back. Okay now spend.
It is an old, old Rubinite strategy from the 1990s. The only thing Robert "What Me Worry" Rubin was ever right about in his disastrous too connected not to fail upward career is.. since mutual fund 401ks, the American public follow the S&P and DJIA like a football score. Up we are winning. The American public can not analyze beyond that. Rubin... the Democrat's version of George Bush… always failing upward.
Speech or wind baggery now over.
I think you are asking the right questions and provide interesting analysis. That is a well supported conclusion. I shall migrate over and read some more. Thanks.
This is excellent analysis. Another thing worth looking at is the growth in household debt according to the age group of the principal wage earners. What we need to see very clearly is that there has been a debt explosion in the younger age groups, which will leave an impossible burden (think college loans, credit cards, unsecured debt, mortgage debt, municipal debt, national debt, social security and Medicare/ Medicaid) on a shrinking demographic sector. How they will be able to spend their way out of this problem is beyond me.
The debt of the young is nonproductive. It is only destructive. They have no future.
My Grand mother was born in 1900. Her description and stories of the credit of the roaring 20's and the Great Depression, are more in line with today than the idea that based on phony GDP numbers we are now post recession as of 7/09. She scoffed at the pigman's usury her whole life. Unlike the Fed,Congress,and the banking industry. The american consumer is being forced to recognize and dispatch debt. Debt free is very addicting few that begin this journey ever return to being debt slaves. Herd mentality has shifted away from credit. JS6 is chopping CC's and walking away from scam mortgages. CC's at 29% is proof the banks are toast,the consumers usury is not coming back and they know it.
Except for the timeline I found your post to be first class and spot on!
Good information. Strong analysis. Logical conclusions. Beastly awful writing. I wrestle with my grammar demons, but I felt like I was drunk reading this piece.
Great article but I wonder about one factor not mentioned.
I assume that as individuals default on their home mortgages and Credit Card debt if this doesn't lower these numbers and if so by how much.
I saw that and wondered the same thing. I think the author(s) probably could have cleared that up with a caveat: Debt reduction is a combination of people still having jobs using their wages to pay down debt, and people without jobs or meaningful wages walking away from debt, and foreclosures in housing wiping huge chunks of debt off the books.
Though if they really did mean "just people paying off debts with wages diverted from consumption" then there is a still darker side to all this.
cougar
one of the best bits of analysis and commentary I've read in some time.
It's clearly different this time,this is no ordinary inventory driven recession.I jsut need someone with more brains than me to collate it and explain it.thanks contrary investor.
Most of the discussion was directed at investors who were being invited to "think outside the box" and to accept non-linear behaviors from this recovery.
But the subtext was (I believe) that the middle-class is being destroyed.
The middle- (or merchant- ) class was the great invention of the Middle Ages, sustained up to now by revolutions or various kinds, both bloody and not, and now being eaten by the oligarchy.
As HP Lovecraft put it in a different context; we were not meant to journey far.
cougar
This is a fine analysis of why 'this time it's different'. The mainline media having by and large sold out to Wall Street and the US Govt. refuses to recognize anything that is not upbeat and geared to making the consumer more willing to part with his/her cash or credit.
There is also too much diversion of attention being caused by the mainline media's constant harping on 'the recession being over'. The so-called 'recession' that we just experienced is only one piece of evidence that the interdependent financial structure of the world is going through a total realignment. We are passing out of the end of the Bretton Woods phase of world finance and into unknown territory. In the future, the US$ will lose it's reserve status and will be replaced by something that the financial experts of the world hope will be more stable. Maybe they'll get it right, maybe not; that remains to be seen.
America is losing it's power to manufacture and purchase. It is losing it's ability to produce oil and minerals, and it is running out of water. Only our military power remains. When a country finds itself in that position, it is only a matter of time until every problem looks like a military option is the best solution. Then God save us all!
The conversation between the econometrics camp and the long run credit/debt cycle continues here at ZH.
People are realizing or feeling that the game is stacked against them. The only way to not get screwed is to withdrawl and not play. I think that is what people are doing.
For myself - I moved to cash (no debit or credit cards) and am stuffing as much into savings as I can and not buying stocks. I'm an investor not a trader and I don't see the market as a good bet right now. I moved my money to a credit union as well.
People are realizing or feeling that the game is stacked against them. The only way to not get screwed is to withdrawl and not play.
+1
That's a polite way to put it.
I suspect that people are realizing they've been parasitized.
For a while now, the talk has been "the markets are not fair." But shortly the story will be that something has lodged in our gut, is attached to an artery, and is slowly draining our life away.
That too is not fair, but at another level of horror.
cougar
No worries. If the US consumer doesn't spend the government will spend more. So far they seem to be more than making up the difference.
http://www.youtube.com/watch?v=LO2eh6f5Go0
hilarious in an all too 'funny because it's true' way
CI said: "As you can see above, the average for this ratio [household debt to GDP] over close to the last six decades was 53%. There is no way we are going back to that level any time soon and we do not expect current cycle reconciliation to come even close to that number."
Can someone please explain to me why it is inconceivable that this ratio might drop to average levels during this cycle? Is this an upward trending series, where debt can grow to the sky, or is it a mean-reverting series where debt levels wax and wane?
It seems closed-minded to assume that a trend that has overshot to such a degree on the upside can not overshoot significantly on the downside.
I would seriously appreciate some comments on this.
Gestalt
Perhaps he was being conservative as to the degree of deleveraging. Personally, I think when the masses realize the true nature of this "recovery", and factor the following into our future prospects, savings should accelerate:
1) structural damage to our productive job base. Financial engineering doesn't count.
2) historic debt levels, now well beyond the peak of GD1
3) excessive dependence on foreign energy
4) excessive dependence on cheap foreign goods
5) deterioration of our eductional system
I think I'll stop there. I'm depressed enough.
The author is taking the same approach that was (until recently) taken by climate scientists; It's not good, it might get worse, but let's be realistic about the risks.
More recently climate scientists are increasingly become oh-my-f*cking-god-wtf-has-happened-we-are-all-dead, or something to that effect.
This is not because they are suddenly all become pansies. It's because they kept looking at the numbers and everything is getting worse at an accelerating rate, when even self-protective researchers who never put a toe out of line suddenly become un-nerved.
The economists will have their own Road to Damascus moment. Probably sometime next year. Then it will become fashionable to speak openly of the end of the world.
cougar
Convincing, well thought out argument. I've stored a copy off line for future reference along with another I read from ZH a while ago.
http://seekingalpha.com/article/156321-a-granular-look-at-the-stratified-u-s-consumer#comment-631578
Terrific research!
I meant to link ZH article, not my 2 cents.
http://seekingalpha.com/article/156321-a-granular-look-at-the-stratified-u-s-consumer
As a mid 20s married person we have roughly $150k of school debt, one unemployed, one in professional school. I'm not worried because my spouse will be a relatively well paid healthcare professional soon so what appears to be a lot of debt isn't that bad if you live in a rural area.
The interesting problem the U.S. will realize they have is all of the people in their 40s and 50s who were buying McMansions and spending all of their potential savings on new home payments. In your late 40s or 50s people in the U.S. were historically finishing up paying off their home, not taking on a new mortgage. I think the last decade has been unique in that people have been buying homes with substantial mortgage payments in their 50s when historically people without a large amount of assets have not done this. How does a middle class worker retire if they have 20 years left on a mortgage paying $3k-$6k a month?
Seems like falling home prices have just begun. Do you choose retirement and a foreclosure or work until you die and keep your home (this assumes that someone is healthy and has the option of keeping their job in their 60s-70s).
The demographics are bad for the U.S. and much of the developed world but the housing boom put a new twist in things.
I believe we could see decades of McMansion prices declining as older home owners flee and younger homeowners have no interest in maintaining and heating/cooling poorly constructed homes. If you talk to public home builders they expect their homes to last 30 years at most, time will tell if they even last that long. Imagine buying a 20 year old KB Home McMansion? It would probably be better to knock it down.
You overlook something: For many in their 50's, these investments (homes) were their retirement. Having watched home prices soar during the Greenspan easy-money days, they figured they'd strike it rich and bail out.
Now they have nothing. Literally.
They will not retire. Ever. They will work until they die just to eat.
I speak from experience, as I am 50 and bought a home (my first) 5 years ago, though I bought essentially a cabin. I can manage my $2K mortgage, so long as I have a job, but many of my peers must be white-knuckled by now.
However I fear greatly for anyone in their 20's with $150K debt. I'm going to see that my children never take on a dime of debt certainly not for education. The future is simply too uncertain now for anything at all like that.
cougar
Assuming of course that overgrown liabilites do not force the government to walk away fron said overgrown liabilities ... resulting in a glut of healthcare over capacity.
Agreed - facts supporting the view that we are at the end of a certain freewheeling era that is rapdily receding in the rear view mirror. Couple this with a reading of the current post at automaticearth.blogspot.com and plan accordingly.
This is a fine piece, Contrary Investor, thanks. As some have already mentioned, the home ATM machine is no longer in service, and businesses don't need to borrow in this environment. I think we can look forward to more of the same as long as housing prices remain low.
Many thanks for this illuminating piece by Contrary Investor. I also liked Problem Is's comments.......this all adds to my education.
Great piece... rumour has it Santa may include a "dose of reality" with the "lump of coal" we're all sure to get this year... unless, omg... could Goldman have a direct line to him to?
US households no longer trust the government, realize that it’s everyman for himself, and are putting up first lines of defense. They also don’t need anything. So much demand has been pulled forward these last several years that everybody already has a new car, refrigerator, laptop or flat screen TV, and replacement need won’t be felt for years.
You made me laugh, though you probably didn't intend to:
We don't need any of the things you listed.
That wasn't even real need being pulled forward, just pleasure seeking in consumption to make up for the shallow ennui of life as it has become in the middle-class.
Those days, for certain, are over. Expect brisk sales of seeds, gardening supplies, sewing machines and hand tools.
And then a long, sullen silence.
cougar
Great article. A few related thoughts come to mind:
1. Our government is far more worried about deflation than inflation. They are willing to risk inflation because that would be the preferable outcome (for a lot of reasons).
2. They are throwing money at everything in sight but they are essentially pushing on a wet noodle. As the article points out, consumers are not consuming and won't consume if it means taking on more debt. This is a huge problem for our all-knowing financial experts. The only thing they can do is to keep the money spigots open.
3. Given all the excess production capacity we aren't going to see any immediate resurgence in hiring. Joblessness will continue.
4. All of the above portends an eventual collapse of the inflated asset values that were created by the credit expansion. The excess money will hold things up for a while but will just make the ultimate "big bang" worse.
The posting really hits the nail on the head, in my opinion, because it gets right down into the meat of the "problem".
Excellent article that explains and quantifies the difficulties facing the U.S. going forward.
I have always been a "free trader" but I am coming to believe that free trade has (mostly) benefited the wealthy (I am in that group). However, I started poor (born into a home w/o indoor plumbing, started in cotton mill at 16) and made my own way.
I wonder if we do not need to return to protecting our borders (both in re. trade and immigration) and restructure our nation to provide jobs and a chance to succeed for any one willing to work. Right now, I don't think even those with good work ethics will have a chance to support a family unless we rebuild our manufacturing base and accept a lower, but sustainable standard of living, even if it harms our financial centers and the ability to create wealth by moving paper (or electrons).
Families can survive mild poverty if they have productive work to give them dignity and a belief they control their destiny. Living on the dole destoys individuals and families (and eventually societies).
There is a factor that seems to be ignored in all of this economic analysis. This is repairability. Almost everything is labeled No User Servicable Parts Inside. This includes the fuse! Up until the last 20 or so years the lifespan of a consumer good could be doubled or tripled with a low investment. A fuse is ~ .40 cents. suppose some manufacturer got on the long usable lifespan bandwagon. Consumers maintaining quality of life at a large reduction in expenditures could really mess up the governments' socia; plans
thanks CI
this read is worthy of everyone's time, including your President's
Perhaps OT, but still very interesting
http://www.youtube.com/watch?v=zioAIZqcLsQ&feature=related
(stolen from someone's post at deepcapture-thought it deserved to be seen by a bigger audience)
I just know the SEC commissioners are sitting up there on the grand podium looking down & thinking "You didn't go to Yale. hmmm... Sucks to be you"
No wonder the American investor has lost confidence in this fucking rigged market. Their all in on it. The Fed, DTCC, Congress, mainstream media. They are, collectively, "the mob"
Harvey,
Thank you so much for the link... not so sure about the Yale comment though... the acting SEC Chair is clearly "dumb as a post" (Part 4 question) and, remarkably, appears to know nothing about the business she is supposedly "regulating(?)."
A powerful "must see," that puts a very real (micro) face on the corruption we all fight on a (macro) level each day... thank you again!
mg
Nice article with a lot of pieces pulled together that you generally won't see in the MSM.
There was a great piece by Chris Puplava months ago called "Turning Japanese" that drew on work by Robert Shiller and others on the links between demographics, consumption, and stock market performance. http://www.financialsense.com/Market/cpuplava/2008/1217.html
Based on that information, and other observations over the past few years, I think ZH's analysis may be a bit on the optimistic side.
Japan had much higher personal savings and was in a better fiscal situation going into their demographic decline that the US is currently. The US is entering a new era with at least one fiscal arm tied behind its back.
Layer on top of that the fact that we have federal and state "social security" programs that truly deserve the description "ponzi scheme". I have also seen articles that indicate that many major pension funds sustained losses of up to 25% to 30%, just a few years away from ramping drawdowns as boomers retire. I also remember a WSJ article several years back that indicated that the average household net worth of people entering retirement was only $100k, and that debt levels had risen significantly among the older set. These stats indicate that many older folks are very ill-prepared to deal with benefits reductions, and when/if they occur, it will cause a lot of pain. To riff on the season, it all adds up to a likely nasty witch's brew over the coming decad
In typical fashion, the government will probably wait until it hits the fiscal wall before attempting serious reform, if it is still standing at that point. If it tries to address it before then, whether in earnest, or superficially - it is likely to either raise taxes directly or indirectly (inflation comes to mind), cut benefits, or a combination thereof. Any of those approaches will likely reduce consumption, at least in real terms.
Also, younger folks have tended to spend more of their income that older folks (those with college aged kids excluded...). However, if you have older folks staying in the workforce longer, or reentering it due to humpty dumpty nest eggs, how might that affect the relatively spendthrift younger set, particularly if they can't find a job? How might seeing the effects of this shift and the debt fallout affect their longer-term spending habits?
Not to be a Debbie Downer, but any way I slice it, it's not going to be smooth sailing in the next few years.
Just wanted to add my voice to the chorus praising the article. A number of comments were interesting as well.
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Fantastic post ... well thought out and well presented.
In summary ... this tells me that the positive GDP was all Mr. Gov spending and we are really still in the recession, dipping to a lower bottom.
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