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The Sustainability of Economic Recovery
The consensus of an economic recovery has gained currency recently, which makes me wary as a contrarian. Most people are blinded by the rally in stocks, equating rising stock prices with economic recovery. One should keep in mind that the Nikkei has experienced several explosive bear market rallies over the past 20 years, yet Japan has been mired in what effectively is a Depression.
What we are experiencing is a mammoth credit contraction, which is a long-term, secular event that occurs periodically with periods of extreme optimism, in which all investments seem riskless, followed by periods of extreme pessimism and risk aversion.
Under the current structure of our economy, there can be no sustainable recovery without strong consumer demand. Real economic recovery should be accompanied by improving consumer spending figures. Consumer spending is likely to remain subdued due to contracting credit and the repairing of overleveraged balance sheets. While there has been a marginal improvement in preliminary retail sales, if federal debt levels increase alongside consumer spending, then we are experiencing what I would argue is a false recovery.
Credit Contraction
Consumer Credit Outstanding is still falling off a cliff, which makes me wonder what the fundamental underpinnings of this supposed recovery are. Unless Consumer Credit Outstanding starts rising again, as it has in every single recovery since WWII, there is little reason to believe we are on the road to recovery.
The Return of Thrift
The reduction in consumer credit is a function of risk aversion on the part of both banks and consumers. The mass consumption ethos has been replaced by a new trend towards frugality that is significant. Secular credit contractions of the kind we are currently experiencing tend to permanently alter spending habits.
The new trend towards thrift will be reflected in the improving balance sheet of Americans. Households must reduce debt to more sustainable levels. We are seeing the beginning of this process as households have started to save and repay debt. While this is a positive long-term trend, the repairing of household balance sheets will apply pressure to an economy overly reliant on consumer spending. Below is a graph showing the YoY change in household liabilities, which is a function of the retrenchment of consumers.
The repairing of balance sheets will be a long process. The Great Depression serves as a useful guide as to what we might expect in terms of both the duration and magnitude of household debt reduction. Household debt as a percent of GDP went from a peak of about 100% to 20% during the Great Depression. From the graph below, you can see that household debt as a percent of GDP is currently about 100%. Assuming GDP remains constant, we would need to see a $10 trillion dollar contraction in household debt to reach a 20% household debt to GDP ratio, which suggests we are less than 5% through the develeraging process.
The Road to Insolvency
America's Road to Insolvency is being paved with good intentions. For example, extending unemployment benefits to perpetuity is a good way to get reelected, but not necessarily the most responsible fiscal measure. Or how about extending FHA loans at 3% down, which helps puts a temporary floor to housing, but at high future costs. Make no mistake, these are temporary stop-gap measures that will hinder future economic growth.
As long as our Federal debt continues to balloon, temporary improvements in economic conditions should be regarded as mere noise. Our government has received a free lunch of sorts via artificially low interest rates, which has kept debt servicing costs low. However, the idea that the Fed can artificially contain interest rates is being tested right now as yields have started to rise appreciably. If the Fed is unsuccessful in capping interest rates, then overleveraged consumers are going to find it much harder to receive credit and service existing debt liabilities. Both of these trends working in unison suggest that we are in store for a protracted recovery.
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Very nice post.
The point I'd make is: government can force consumer spending and withdrawal of savings, indirectly. They can do so by effectively confiscating a part of your future earnings (through increased future taxes) and by confiscating your savings (through inflation) and then spending it today on things you did not want. Too bad for you; you don't own your own government.
However, the price of the government doing those things is totally unknown; I know of no modern economist who can calculate it (other than the great Krugman, of course, who can do it blindfolded on the back of a napkin). Yet, in spite of having no idea what it costs and also having no idea what is the sustainable upper debt limit, they advocate the spending anyway. Complete irresponsibility.
Excellent piece, nicely constructed.
I wish the average American who doesn't really understand economics would read this piece as it really packs alot into a few paragraphs.
thank you.
hi Deadhead. or coast contractor. No work, so lots of time on internet.
Am immensely grateful to Zerohedge and all who post and respond. Have read this and much more. Watching money masters now and passing it on. Locals have made the usually unnoticed coinshop very busy last 2 months. Silver mostly. Most of our residents are retired, have food put away as a matter of course. Hunters and fishermen love it here as well as the well heeled. Gated communities are in plenty but not obvious.Easier to survive here in the worst of times.
My fear is for the big city dwellers. I am surprised at lack of broken bank windows. If i lived there JPMorgan and goldman sucks would be replacing their glass daily. And thats just a beginning. Stink devices, chewing gum in ATMs and lots more that can be done without hurting persons. They hurt me, my kids and neighbors. Not to mention the future and our country. I am pissed and want to strike back. I am near 60. What the hell is wrong with our people that they stand still for this?>
Bothered
I wouldnt be surprised if there isnt another black friday when it all finally unravels. They will probably be on their 100 foot yachts by then heading to some island resort to take up residence however.
Yo Merehuman,
up here in Portland, OR and live among many of the previously large living developers, business owners, and the like. They are mostly hurting, overlevered, not making any money, and just hoping to hang on for another 3 or 6 months before everything "returns to normal". Most these folks burn bare minimum $10k, $15k, $20k+ monthly and making next to nothing. Beach and mountain vacation homes, five cars, travelling to attend kids in every sport imaginable, and college tuitions. Based on the above info, the return to "normal" just ain't coming and the blood letting will begin for these folks as cash and credit are now mostly gone. These folks all made a half million and up and only now are starting to think maybe they should have saved some instead of always levering up for ever greater returns and ever greater lifestyles. I know it's the same in Cali, Seattle, and likely nationwide. To answer your question, many of these folks have nobody but themselves to blame.
Amen, brother.
George Carlin had a theory on why Americans seem to take shit right in stride.
He theorized that because of cell phones and gizmos of the like, Americans are bought off and can't be bothered with actually making structural improvements to our country as opposed to superficial, meaningless ones.
'mericans don't have time for that gettin' mad nonsense.
http://www.ritholtz.com/blog/2009/11/the-world-according-to-americans/
Actually, Americans can get mad.
It just takes an awful lot for us to get there. But once we are there, we are the Gozilla of Japanese television. When you get us mad, we not only blow the hell out of you, but your country, and your friends countries as well.
What I am afraid of is our bought and paid for congress, along with wall street getting America mad at part of itself. Because if we do get mad at them, we are going to need to rebuild the east coast, and elect a bunch of new politicians.
I have never seen any data on it but would guess that the decline in household liabilities is more attributable to writeoffs of mortgages, home equity loans, credit card debts and other debt than to actual debt repayment. Most people don't have the money laying around to pay down debt at anything close to the rate implied by the second chart.
In Canada mortgages are sometimes tied to prime - so that as it falls they automatically pay off capital. This may be helping in some cases.