In a recent post entitled, “The Stealth Deterioration in Asset Quality,” I argued that the rise in the US savings rate had only begun. That implies falling consumption, a weak housing market, and an L-shaped recession as far as the eye can see. That is just what we observe in the household spending and consumption data, as Bloomberg reported Friday morning:
June 26 (Bloomberg) — Consumer spending rose in May as benefits from the Obama administration’s stimulus plan spurred a jump in American incomes, a sign that efforts to revive the economy are starting to pay off.
The 0.3 percent increase in purchases was the first gain in three months, the Commerce Department said today in Washington. Earnings climbed 1.4 percent, the most in a year, driving the savings rate to a 15-year high. Another report showed consumer sentiment rose in June to the highest level since February 2008.
Government efforts to restore the flow of credit and prop up incomes are making it possible for consumers to spend even as unemployment climbs to levels last seen in the early 1980s. At the same time, the wealth destruction caused by the housing slump may force households to keep rebuilding savings, indicating an economic recovery will be slow to develop.
How fast the savings rate increases, as Nouriel Roubini told Bloomberg, determines whether the US sinks further into a recession or keeps one nostril above water. The point of Keynesian government spending is to replace lost consumer spending with increased government spending. That creates a “sugar high,” especially when the government’s capacity to borrow is constrained by the refusal of global investors to continue adding to their holdings of US government debt. The negative multiplier occasioned by the retrenching of consumers (lower spending, more unemployment, lower incomes, lower spending in a vicious cycle) is stronger than the Keynesian multiplier from government spending (more government boondoggles for construction unions, more spending).
There are ways to break the vicious cycle:
- encourage entrepreneurs to dive in and take risks
- encourage foreign investors to put more money into the US economy
- attract skilled and talented immigrants who bring in human capital.
The trouble is that entrepreneurs at this stage of the cycle appear as vultures, speculating in human misery, buying foreclosed houses and distressed bonds. By denouncing the Chrysler bondholders as “speculators,” trampling on their contractual rights in favor of the UAW, and threatening to destroy their reputations, the Obama administration has served notice on the prospective entrepreneurs of the world that their rights won’t be respected. So forget about alternative number one.
Alternative number two would work if the US government allowed the Chinese and others to come in as partners and buy significant parts of the US economy at discounted prices. That’s not going to happen, either, for the same stupid political reasons. As for US government debt: the Chinese are torn between protecting their multi-trillion-dollar investment and diversifying out of it. They are cautious people and will do nothing quickly, but I am gradually moving assets into dollar hedges and would advise others to do the same.
Alternative number three isn’t even on the agenda.
That means we are stuck in a vicious cycle in which the recession lasts indefinitely, equities chop sideways forever, and the Obama administration sets the stage for a potential dollar collapse some time down the road.