The New Unwind 32 comments
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No one expected good news, and the expectations were met.
Today’s update on 2008’s fourth-quarter GDP was ugly, the ugliest in 25 years, in fact. The economy contracted by 6.2% at a real, annualized seasonally adjusted pace in the last three months of 2008. That’s much deeper than the 3.8% decline originally estimated by the government.
Painful, but no one should be shocked, given the general economic and financial climate. But let’s be clear: The embedded message in today’s revised numbers from the Bureau of Economic Analysis is sobering. The principal reason it’s sobering is that the main driver of economic activity has stumbled, and the prospect for a quick turnaround is about as likely as waking up on the surface of Neptune tomorrow.
It’s not an exaggeration to say that consumer spending has hit a wall and crumbled as a result. Perhaps the only surprise is that it took so long for a retrenchment in consumer spending habits. But fate can only be delayed so long. The willingness, bordering on obsession for borrowing in 2002-2007 has finally come back to haunt Joe Sixpack, and by extension the wider economy, which is heavily dependent on personal consumption expenditures. The implosion of the financial industry has, of course, exacerbated the trend, as has the collapse of the real estate bubble. In short, a perfect storm, the effects of which are only now being fully realized.
America has long been a nation of consumers, and there’s much to cheer about on that front. Consumption generates economic growth and spending has been no small part over the generations in powering the American dream of building wealth and prosperity. But there’s a limit to everything, and at some point even a good thing becomes excessive. At some point in the recent past that limit was breached.
Excess certainly looks like an appropriate label for consumer borrowing in 2002-2007, when the household balance sheet became laden with debt to an extent that was as shocking as it was fated for a day of reckoning. The details are there for anyone willing to take the time and pore over the Federal Reserve’s Flow of Funds Report.
The reaction to the mountain of debt is now underway. As our chart below shows, consumers are finally facing facts and cutting spending. If a purchase can be delayed, it will be; if spending can be minimized, it is. No wonder, then, that durable goods spending — the so-called realm of “big ticket” items like washing machines and refrigerators — is falling rapidly. If you don’t need it, you don’t buy it — the new mantra of for a new generation of consumers who’ve been dragged kicking and screaming to this revelation of unvarnished necessity. Only services spending has been spared, which is largely a function of essential services like medical purchases in this category.
The bottom line: Consumers are aggressively repairing their balance sheets after a long stretch of doing the exact opposite. The front line in the restoration is cutting spending, anywhere and everywhere. This process has only just begun. Given the magnitude of the former excess levels of spending and debt creation, the mending of household balance sheets will run on for some time, probably for far longer than is widely expected. The repercussions will be far and wide. It’s not the end of the world, but it is the start of a new era that will reorder the consumer mindset.
Exactly how long this pullback rolls on is the question. For now, it’s clear that the unwinding is upon us, and the worst of it is going to roll on for several quarters, perhaps several years. It’s a process that’s long overdue, fundamentally necessary and destined to be painful. Coming to terms with reality is never easy, but it is refreshing and healthy…eventually.
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--Remember when gasoline prices finally settled down after the Katrina run up and people flocked right back to SUVs? People have very short memories.--
You apparently did not grow up with parents that lived through the Great Depression. I assure you, with the right set of events, your memory gets very long indeed.
--The idea of the "rational man" can go to the dustbins of history as our new models show that even the smartest people can succumb to groupthink and the madness of crowds.--
Our new models show us that? I thought it was shown as early as the bursting of the Great Tulip Bubble of 1637. Such folly was examined in "Extraordinary Popular Delusions and the Madness of Crowds" by Charles Mackay in 1841.
I know many intelligent people that acted like idiots, and that's no excuse....
I realize a solution may not be fair to all, especially people like me that played it safe but will have to share the burden. But no one should grant immunity to the general public in this fiasco...
On Feb 27 02:18 PM techzone12 wrote:
> The average Joe is not exactly responsible for this crisis. He was
> basically used. The banks encouraged people to take loans that they
> could not afford. And who doesn't like easy money? Who doesn't dream
> about becoming rich one day?
> Meanwhile the government (and the politicians) stood by and did nothing.
> Why? because they can not bite the hand that feeds them. Some people
> got rich in the process (Madoff anyone!). Meanwhile things went full
> circle, and the "average Joe" is the one who ended up picking up
> the bill!
I do share the sentiment of some of the commentators, like Aristophanes, who are laying the blame squarely on the shoulders of our financial elites. It is true that they have made out like bandits in many cases, but the average person does share the blame. But not because the average person should be a wiser consumer of financial products. The average person shares the blame becasue that person is a voter, and this country has voted over the last 30 years or so for massive deregulation of the financial sector.
Many Americans bought into the myth that they could be shrewd investors and make millions just like the professionals, and they let their greed overcome reason. This irrational overestimation of ones abilities is dangerous. This overconfidence and greed on the part of the average citizen and the self-aggrandizement of the financial elites have driven us to this cliff. Those elites took advantage of the rest of us, but that's just part of human nature. Only fools like Alan Greespan thought that unregulated bankers would be virtuous. Of course, people like Alan Greenspan with their libertarian nonsense played a part in this debalce, but we were fools for listening to that siren song.
In the future, it might be best to have some financial regulations in place that will stop us from giving in to our irrational desires. The regulations bind us and prevent us, in moments of weakness, from harming ourselves. Odysseus did something like this when he ordered his crew to tie him to the mast so that he could hear the songs of the sirens without being devoured by them. Regulations like this are not an admission that we can't govern ourselves; they are an admission that we are human beings.
Finally, I disagree with the comment that assessing blame is counter-productive. Assessing blame is important because it requires us to examine the past. We have much to learn from history.
One way or another, we couldn't keep running an economy on fumes alone.
As others are saying, this doesn't necessarily mean anything long-term in a change to our habits, but for that front, we'll all just have to wait and see.
1. with an estimated 95% of our aging population holding ~90% of their net worth in their primary residences, consumerism as the main driver of our economy is in a near-catatonic and terminal decline. Our buying habits were spurred on by an illusion of wealth.
2. personal consumption will decline to a level that will thrill the most prudent 1950's guidance counselor. Retail? Watch for the huge sales and mass closings; many big names are about to fail.
Bob Dylan sang 'The times, they are a changing' many years ago. Changing, they finally are!
On Feb 27 01:49 PM Lilguy wrote:
.........
> That the change is being forced upon us by massive wealth losses
> in homes and investments as well as huge unemployment increases just
> shows how much we have avoided the need for years.
>
> My key question is at what level will personal consumption settle
> out?..... what are the many implications for the retail
> industry--goods & services--in the US (& maybe the world)?
When I bought my house, the agent tried to get me to look at more expensive houses, I had contractors try to sell me expensive upgrades that I had no need for (never use Mid-Atlantic Waterproofing, BTW) and even when I got a $25,000 business equity loan on my home, they tried to sell me one for $100,000! I listened to these people and told them I didn't need any of what they were trying to sell me.
I feel badly that a lot of people have not been raised to understand the value of money and easily buy into platitudes like "housing always increases in value", "stocks always increase over 20 years", and "you should put 10% down on your mortgage". None of this advice is useful when not put in context. But I feel worse for people who worked their whole lives and were financially sensible and now their pension or retirement savings will be worth pennies.
'deleveraging' however, is based on the concept that we had been an extremely overleveraged state and in the process of 'returning to the mean', back to historically normally leveraged state. I don't remember what that supposedly normal leverage ratio is, but according to that theory, by the time this 'deleveraging' process has returned us back to normal leverage ratios in the economies, the S&P500 will be closer to 600, not considering the high possibility of overshooting to the downside during panic selling.
The bad news is: those who have been making bearich predictions based on this deleveraging theory has been most consistently and unwaverringly bearich through out the downturn and therefore has been most accurate. For now this seems destined to continue for some time.
Long after boxing day the "Boxing Day type' sales flyers keep coming to my door. When I see quality products offered at 70, 80 an even 90 percent off the regular retail prices I get interested. Now is the time to consume. But that consumption should be done in a strategic way with a long-term view in mind. For any of you who believe that we have serious inflation in the future you should consider stocking up on those goods, particularly imported, that are available now at fire-sale prices.
Remember the maxim, "buy low, sell high". Now ask yourself why it makes sense to buy products at full cost like there is no tomorrow, yet shun the greatest bargains we have witnessed in a decade. Some of the best deals I have seen in my life in fact are happening right now.
These are indeed the good old days. We will look back on this time and wonder what we were thinking by not shopping when the best of all goods were priced for quick liquidation.
There is a bigger concern though, and for those of you who follow international trade, read the Baltic Index and are aware of widespread manufacturing closures overseas, shipping and trade fall-backs you will sense the urgency of my next remarks. Global Goods Supply is drying up rapidly. Simultaneously, we are witnessing massive infusions of new money into the system. M1 growth is staggering but it is only a snapshot of what is actually a bigger picture. A similar expansion of the money supply is taking place in concert all over the globe. Indeed, most of Europe is in an eerily familiar currency expansion phase. This means inflation is in the future in a very big way. And staggering interest rates will only follow in due course.
But the point I am trying to make is this.
In an environment where the supply of goods is rapidly diminishing due to economic circumstances and while the the Money Supply is rapidly increasing to cure that economic problem, the only outcome can be rapid inflation. Brutal inflation. Double digits. God forbid not more.
So to return to my original idea. This is a very good time to buy consumer goods. Buy the bargains and the sales. Buy the things you need or those things you can use as trade-goods in the future. We are at or near the maximum buying power of our dollar and have not had this opportunity in decades. Nor will we see it again soon. Currently, prices of manufactured goods are down significantly, even to historical lows, while the dollar is up (and increasing in value relative to the Euro and most other currencies). So take your appreciating dollars and buy the best sales bargains you can get.
Stock up on extra things too. I can assure you that shopping in the future will be something you will avoid like the plague as prices spiral out of control and the dollar simultaneously tanks.
Think it through. Then go shopping! And have a great year!
Cam
Instead of 8 McDonalds in town, there will only be 2. Instead of 3 WalMarts, there will be only 1, Instead of 4 Starbucks, there will be none. But, hopefully, there will be a couple of new factories that actually make something where the store clerks and burger servers can get a productive job. And, again hopefully, there will only be about half as many people with government jobs that produce absolutely nothing.
Annualising to get everybody's attention is bellow the belt economics, unless you are predicting 3 more quarters liked it, with more of the same analysis as you have done.
> Great article and chart, but do we really think the U.S. consumer
> has *finally* learned their lesson?
Yes. There is ample evidence of generational patterns. Try Googling "4th turning" and do a bit of research. The world tends to force that learning on us every 70-80 years by way of crisis. Remeber that little thing called The Great Depression? Oh, and then there was WWII to really teach us that there is a big price to pay for all that we have and enjoy, right down to our loved ones.
> GDP has not fallen 6,2%, only 1,4%, from 14,4 trillion to 14.2 trillion
> this IV th quarter. Up from 14 trillion a year ago. Get your numbers
> before spreading doom and making all of this a self fulfilling prophecy.
It's good that you point that out so everyone knows but that is the way GDP is normally reported.
To put it in perspective GDP dropped about 30% during the 1929-1933 period and that means about a 10% annual rate of decline for 3 years. We are nowhere near that but a deflationary spiral tends to feed on itself, as we are seeing, until all the leverage is deflated out of the economy.
> What's wrong with 'deleveraging'? It's a more precise concept than
> the vague concept of 'unwinding'. 'unwinding' does not tell you when
> the process will stop.
>
> 'deleveraging' however, is based on the concept that we had been
> an extremely overleveraged state and in the process of 'returning
> to the mean', back to historically normally leveraged state. I don't
> remember what that supposedly normal leverage ratio is, but according
> to that theory, by the time this 'deleveraging' process has returned
> us back to normal leverage ratios in the economies, the S&P500
> will be closer to 600, not considering the high possibility of overshooting
> to the downside during panic selling.
I have been researching "fair value" for the stock market for over a year and it is indeed somewhere around 600. Given that a secular bear market always seriously overcorrects beyond the mean indicates the S&P almost assuredly will go to 300 or below.
> In the future, it might be best to have some financial regulations
> in place that will stop us from giving in to our irrational desires.
> The regulations bind us and prevent us, in moments of weakness, from
> harming ourselves.
We had them and then we decided we didn't need them. I recommend you spend a few hours over at www.generationaldynami... and read John Xenakis' weblogs. He has done a great deal of research on Generational Patterns and has built on the work of Strauss & Howe, who wrote "The Fourth Turning", a well researched book that attempts to explain why we make the same mistakes over and over and suggests that we can predict these "turnings". They predicted a new 4th turning around 2007; the 4th turning is when the survivors of the past crisis era (the 4th turning takes us into a new crisis era) have all been replaced by a new generation who think "it can never happen to us". We are them.
An easier read, without so many predictions is at www.bullnotbull.com/ar... - it might be a better starting point.
Wow--if it isn't Reagan, it isn't right. Is that it?
How is that right-wing Reagan-esque capitalism working out for you right now? Stay that course any longer and you will be without a country.
Give your head a shake---maybe Fox and CNBC will fall out your ears.
On Feb 27 02:06 PM Steve in Greensboro wrote:
> Don't worry about consumption. What the consumer isn't spending,
> the leftists in control of the government are going to more than
> make up for.
-consumer spending (demand side) has driven our economy for a long time
-Durable goods spending is the most volitile drag since it can be deferred
-higher unemployment leads is less demand
-bailing out excessive risk takers, be it banks or individuals leads to moral hazard
-We all benefited from the demand side bubble and twin deficit spending
-we will all pay whether we got caught (overborrowed or lost our jobs) or sell to those who did ----OR----
-only the government can afford to do the irrational thing (spend) and we will pay (and the next couple of generations) to minimize the unwinding
-very worst case --- it will take a world war to finally get us out of this as in the great depression. And, I would prefer other solutions, or at least a try, even if I lose some of my accumulated wealth(small as it is) whether it was partly my fault or not.
In it is pure economic text book scenario, the price should wind down; unfortunately, now the homeowner are both producer and consumer.They buy the house and wish for increasing in value and now find the hard sad truth.
The stock market and real estate are great inventions by making average joes sort of owner of the "profit-sharing" capitalist machine. The often quoted comparison of "great depression" and now is the ownership of stock and house was far less popular than current situation. All those pension fund, 401k, mutual fund get everyone tangled with each other. Unfortunately, there is no Alexander to cut the Gordian knot.
Today there are talking about S&p down to 300 with p/e=5 and it seems the market can quickly adjust and find new bottom--which is even "better". Because after that the grow rate should be phenomenal.