Consumer Credit May Drive Our Recovery

Consumer credit is down in July 2009 based on preliminary data. The headline splashed about was that credit contracted over 10% annualized between June and July.

There are several problems with the data. The first is the most obvious – the data is over one month old. The second is Cash-for-Clunkers. We know that a majority of these new cars were sold with financing. And the big month was August. It may have added $10 to $15 billion of consumer credit financing which is half to three quarters of the amount of the decline.

We will find out next month whether this credit decline was transient when the quantitative data is released. The Federal Reserve in its subjective Beige Book release this past week said the demand for credit is still contracting.

So let us say that the credit decline is real, and the downward trend will continue once we pass the effects of Cash-For-Clunkers data.

As consumers have used credit to fund their shopping spree, this means less spending. As the American economy is driven by consumer credit, this does not seem to bode well for a strong economic recovery in the short term.

Conventional wisdom says the consumer is tapped out. They have built up mountains of debt. Loan standards have been tightened and many do not qualify anyway. This is further complicated by the Boomers getting ready to retire – and their anticipated reluctance to take on new debt.

This is our much discussed "new normal".

We have seen the graphs and tables showing how private sector debt is a big percentage of our GDP, and multiples of income.

The consumer credit situation is bad, but it may not be as bad as conventional wisdom is leading us to believe. The graph below illustrates this perspective:

When we buy a house, borrowing should be limited to no more than three times our income (300%). But when we borrow, we are allowed to include ancillary income from assets, bonds, interest – anything that would be considered taxable income.

But when we are presented the evidence of indebtedness of Americans, it is always against GDP or salary / wages which exclude ancillary income. This means that ½ of the income of consumers are excluded (see here and here for background).

The above graph uses the total income of individuals – regardless of whether that income was part of GDP or not. This data is drawn from the National Income and Product Accounts (NIPA), which are the same tables from which GDP is cherry picked.

The debt used in deriving this chart is the same as most other economists use – from the Federal Reserves Z.1 Flow of Accounts Table D.3.

The debt load being carried today by private individuals is 115% of annual income. The debt load includes all debt (mortgages, revolving, non-revolving, etc). On a historical basis, it is double the 1970’s, but still far from 300%.

I am not implying all debt is the same, but the majority of the private individual debt is real estate. This is why thinking of the 300% number puts the overall debt burden into perspective.

I am not implying that a significant portion of consumers are not at their credit limit. But aggregating all income levels likely distorts common wisdom.

Looking at the above graph, the level of debt was actually not bad until 2000 based on historical norms. I say this based on the ability of the economy to grow, and not on the use of any formula. If you have been following my articles, I continue to maintain something happened around 2000 which caused employment declines and other economic changes we are still living with today.

I think there is little argument that our economic growth after 2000 has been anemic. I would suggest that the continued growth of credit spending had a hand in our poor economic performance. Additionally, growth of credit spending as a percentage of income was unsustainable and set the stage for the collapse.

One final point to put debt into perspective, the graph below compares the debt to income percentages of the three major groups of our economy.

The debt of consumers (“private” in the previous graph) is roughly the same as business – yet few are saying business is overextended.

But what about government credit spending?

The debt for the government in the above graph is based on federal, state and local bills and bonds – and not based on the infamous debt clock which includes unfunded social security benefits. If that debt was used the percentage would the 850% vs the 500% shown.

This government debt is now growing exponentially. What most are watching is the debt clock, but what should be watched is the amount the government is borrowing. This is not the same as the debt clock as they have been stealing funds from social Security and Medicare surpluses to cover a portion of the debt clock debt.

Those days are over. Now almost 100% of budget shortfalls need to be covered by borrowing. It should be obvious that the government does not have the means to ever pay off the borrowing. Those arguing that economic expansion will solve this problem are ignoring the rate of growth of government debt.

It is the government, not the consumer or business, who is caught in the credit death spiral. More and more of the budget will go for funding this debt. In order to keep America from going bankrupt, the Fed may have no choice but to keep their benchmark rates at nearly zero FOREVER.

This possibility opens Pandora’s box which I will leave for another time as this subject is a digression from consumer credit and debt.

Back to consumer credit and debt consumer debt is:

• higher than historical levels; and
• most likely at an economically detrimental level. The cost to consumers of maintaining this debt is diminishing spending on goods and services which would expand the economy.

Our economic controllers may choose to continue to exercise politically expedient short term policies to use credit to re-expand our economy. After all, 2010 is an election year, and no politician wants a bad economy.

There may be possible room for expansion of credit.

Maybe the consumer can be coaxed into spending - not today but as soon as the economic train gets on the right set of tracks. Historically, the consumer has always come back. Many believe this time is no different.

Maybe the banks tightening of credit standards are not the governing factor in credit expansion. It is possible that any increase in the demand for credit will be met with new financial credit products so that even the over extended can borrow.

Maybe based on the above graphs there is room for growth, but I still believe the Boomers will not come back to the well to take on new credit.

Maybe we can even coax spending from Boomers. All it would take is expansion of existing financial products like reverse mortgages. You cannot take your money with you – and if any generation can figure out how to actually spend their last dollar on their deathbed, it will be the Boomers. Watch out for new annuity products aimed at the Boomers.

Maybe if the markets continue to run up and housing prices begin to build their next bubble, we will forget about our Great Recession. We will jump on the merry-go-round and grab our brass ring.

There is no Maybe - we are a greedy lot.

Manufacturing and Business

Wholesale trade showed a 0.5% MoM sales increase in July 2009. But this was using seasonally adjusted data, and the non-seasonally adjusted data fell 2.4% MoM. Anyway you cut it sales are down 20%YoY and seasonal data is suspect at the end of a deep recession – I suggest there is not really any conclusions we can draw from this data. The data itself was fairly uniform, and specific trends could not be identified.

Wholesale trade continued to shed inventories in July 2009 which negatively affects GDP.

Prices for import and exports increased slightly in August 2009. Both export and import are continuing their trend this year of MoM price increases. Last year, the trend was MoM price decreases. A continuing trend line of price increases normally indicate an improving economy.

In this case, with the devaluing dollar and some uplift in commodity prices since the beginning of the year, I am not certain the change in prices have any meaning you can extrapolate.

The balance of trade worsened slightly in July 2009, although both exports and imports increased. Over half of the increase in imports was due to consumer products – and oil imports actually decreased in value. There were no specific reason for the increase in exports but it was interesting that exports of consumer products also increased.

This increase in consumer goods exports and imports is a normal end of recession marker. It demonstrates that the main economic driver – the consumer – is starting to spend not only in America – but overseas as well.

The ASI/Transmatch rail loading report updated through 05Sep09 shows that railroads have broken out of the recessionary levels they have been in so far this year. Transport is used as an economic indicator as goods must be shipped several times before they reach your front door. Sea container counts have not yet been updated for August. I need the August data to be able to confirm the trend which I believe the container count data is beginning to show.

Jobs, Jobs, Jobs

A month ago I predicted the Conference Board Employment Trends Index would turn up this month. The bottom line is the index fell slightly (0.1%). This report is used to forecast the future trend of employment. According to Gad Levanon, Senior Economist at The Conference Board:

The flatness of the Employment Trends Index in recent months suggests that we won’t see job growth until the end of the year. The fact that the index cannot get off the ground is another sign of a weak recovery, perhaps a jobless one.

Last month, I broke down the eight indicators showing where they were. Here are the three indicators that did not perform as I had expected:

• Percentage of Firms With Positions Not Able to Fill Right Now (© National Federation of Independent Business Research Foundation) was getting better and now got slightly worse meaning small business is finding it less hard to fill open positions.
• Temporary employment is a leading indicator for non-farm payrolls (from Jobs report). I believed temporary employment would bottom out in September – and maybe even rise. Here is a graph from Hussman Funds which tells the tale:

• People employed part-time for economic reasons (from Jobs report) increased after being on the decline in the previous month. I did not take my own advise that the July 2009 jobs report was erroneous.

The 4 week moving average of advance initial unemployment claims decreased slightly this week to 570,000. In three of the last five weeks, the 4 week moving average has increased. The four week moving average is remaining in a narrow zone.

In comparing what is happening now to the 2001 recession, similar plateaus occurred. But in the 2001 recession, unemployment claims remained above 400,000 for “only” 52 weeks – we are already in week 62. The 2001 recession only had one week over 500,000 – we are in week 44. The 2001 recession had no weeks over 600,000 – we have had 22 weeks at that level.

The current upward trend should be short lived. This is a common event, not only in this recession – but in past recessions. The decline in unemployment claims is not linear, and baring an unexpected event will continue its overall downward trend in the coming weeks.

Additional Economic Data This Week

The Federal Reserve has issued its monthly report (aka Beige Book) on economic / business activity in the USA for August 2009. I have a vendetta against these kinds of subjective reports – but the Fed continues to get this one right. I consider this document one of the best real time coincident indicators.

Reports from the 12 Federal Reserve Districts indicate that economic activity continued to stabilize in July and August. Relative to the last report, Dallas indicated that economic activity had firmed, while Boston, Cleveland, Philadelphia, Richmond, and San Francisco mentioned signs of improvement. Atlanta, Chicago, Kansas City, Minneapolis, and New York generally described economic activity as stable or showing signs of stabilization; St. Louis remarked that the pace of decline appeared to be moderating. Most Districts noted that the outlook for economic activity among their business contacts remained cautiously positive.

Overall retail sales remained flat, downward pressure remains on housing prices. Income and consumer prices were stable. Loan demand remained weak, and surprisingly was declining across many districts. Commercial Real Estate remains on life support. Manufacturing was picking up. Agriculture is mixed with drought, poor livestock prices, crop diseases, and cold weather effecting to the downside.

Consumer confidence is down this week, has been bouncing around like a yo-yo, and never seems to get traction. This is a primary ingredient in recovery even in the "new normal" which still needs consumer consumption. Lower does not mean zero. This week it is blamed on personal finances.

Consumer confidence requires the government to manage, and have Joe consumer believing they are managing. You cannot tell Joe there is a recovery underway – where is he supposed to see it? This reinforces that the government will say anything – whether it be true or untrue.

The rate of new mortgage applications decreased slightly again this past week but remains in the range it has been bouncing around within since April 2009. The four week moving average of mortgage loan application volume (which includes refinancing) increased 7% WoW, and increased almost 65% compared with the same week one year earlier. The average interest rate for 30-year fixed-rate mortgage decreased 13 basis points to 5.02%.

Filing for Bankruptcy: GigaBeam (GGBM) Trident Resources (TZ) PNG Ventures [PNGX:OTC]

Bank failures this week:

Economic Forecasts Published this Past Week

The Economic Cycle Research Institute (ECRI) released their Weekly Leading Index which is at an all-time high. Lakshman Achuthan, Managing Director at ECRI added:

The rise in WLI growth to a record high reinforces our earlier forecast that at least the early stage of the current economic recovery will be more vigorous than the last two.

We expect non-manufacturing employment -- which is where 91 percent of us work -- to be positive by year end.

We are talking about recovery that includes jobs growth in the non-manufacturing sector, and we are talking about a recovery that includes increases in consumer spending. So, in spite of the fact that many people look at this recession as being unprecedented and unlike any other, what we're seeing in our indexes is that there are a lot of similarities to previous recessions and recoveries.

Hat tip to Steve at MEMETICS & MARKETING for editing support.

Disclosures: long MMF's, GLD, SLV, IOO, EWZ, EWY, EWA, EWC, PIN, Physical Gold - as well as numerous calls which comprise less than 1% of my portfolio.

Comments

[markfl:]

It looks as though the graph of temp employment is trying to form a bottom, a potentially hopeful sign that payroll employment may eventually show steady declines in job losses and even positive growth, even if not sufficient to moderate the actual unemployment rate. Next month's BLS report, if it shows even a .1% increase in the average workweek hours, would mark the turning point in the recessionary trough, and and be cause for optimism that greater labor utilization may occur soon.

Sep 13 05:25 AM

[tjfxh:]

Without a turn in unemployment, the real rate of which is running at about 20%, there will be no significant impetus for increasing consumer debt. Business is not borrowing because of overcapacity. No one else in the world is buying so dollar depreciation is not pushing net exports, and imports are rising because the US consumer dependent on cheap stuff from Asia. In addition, the financial system is capital starved, and is using free money from the Fed to build up reserves safely, which means not lending to strapped consumers.

Money is created from government debt. The government has to keep picking up the slack as long as necessary to keep the system going until the banking system is solvent, and the real economy is creating jobs.

Sep 13 10:49 AM

[John Lounsbury:]

Steve - - -

Great article again. I agree that something big did happen around 2000 and I am not referring to anything that is primarily political. A significant economic tide turned with the popping of the dot.com bubble. The subsequent credit and housing bubble has hidden the "new economic truth". That truth is now emerging. I will finish a paper (that I have been nurturing for months) this week to discuss what I mean in some detail.

Sep 13 03:22 PM

[John Lounsbury:]

Steve - - -

Mike Shedlock agrees with your title globaleconomicanalysis..., but he thinks the bump in comsumer credit and retail sales will be a temporary effect of the cash for clunkers program.

Sep 13 03:28 PM

[cmbova:]

Interesting article and for now I will only comment on the consumer side. I admire the optimism but I just do not see the consumer in the position to lead the country out. Obviously as a business owner, I would love this, but I do think that this period of readjustment will be longer. As you cite, something happened around 2000--which I think was the Greenspan effect--perhaps the Barney Frank effect as well...of very cheap credit, additional credit products and especially products to make housing available to everyone. It became shameful to rent, and this type of credit and public policy push created undue housing demands and rampant speculation.
From my viewpoint, from 2000 forward it would seem that other than these effects, we had anemic economic growth domestically. Instead we overspent--and many consumers "moved up" in housing, financed their other purchases with second mortgages and other credit products on the basis of continuing asset appreciation and economic growth.
The result of this is that anyone that bought a house in the 2004-2007 time frame now has taken a significant bath and may not have any equity. Secondly, those people that did not buy and had bought earlier "milked" their house for second mortgages, etc so essentially they are currently in the same position. They essentially are underwater today as well. I've seen reports estimating that up to 45% of the US population may be actually underwater in their mortgages. I am still not sure if this number includes or does not include second mortgage products as well, so the number could actually be worse. Add to this that although there have been optimistic reports of a bottoming of housing values and very slight uptick in resales (mostly caused at the lowend by the $8000 tax credit), there was a prediction this weekend by Meredith Whitney predicting that housing values could go still lower.
Also I think we are also coming to the conclusion that unemployment may remain higher than we might like for some extended period. It is currently close to 10% and there seems to be nothing on the horizon that would trigger a downward change here. The government's own numbers show that the real unemployment rate (people not reporting, people falling off) actually is running close to 17% and has been increasing at a very alarming rate during the last several months. The fact of the matter is that the economy is still losing jobs--although perhaps less than before. But as we still lose jobs and unemployment payments expire for many individuals, the real unemployment rate is just absolutely terrible. It is pretty obvious that business productivity is increasing--as businesses are finding ways to do without new hires and even as business revenue bottoms out or slightly increases over previous anemic rates, it is clear that business is in no hurry to create jobs. Business is in survival mode and will wait until there are huge squeaks in the system to rehire.
Of course, I've seen articles by traditional economists that think that business inventories are down as a result, businesses will have to increase inventories again--and therefore must rehire accordingly. But instead, I don't see this happening--or if it is it will be done with some overtime and very very slowly. This is anything but the normal response.
Finally there is no public policy to create jobs or to help manufacturers (or any other industry) to hire employees. In fact, just the opposite--the government is continuing to put pressure on us by threatening to increase employment taxes, threatening to increase leave policies--never mind the uncertainty as to what the current health care measures will really bring to employers. Beyond that the government has hired more people to do more inspections of business at the OSHA and Immigration check levels. All of this has the bottom line effect of sending the signal--don't add employees. Make do with what you have--or if you are really smart, continue to lean out the enterprise by cutting employment further. So far the stimulus money has primarily gone to state and local governments to prevent further job losses, and has done nothing to truly stimulate job creation. (It is likely that the feds will have to support state and local governments for years as the real issues are just hitting the fan--unemployment funds are increasing broke (state responsibility) for example, so it is quite possible that the feds will take on more and more responsibility and power out of necessity here.)

So the bottom line...
In my opinion, we are absolutely a greedy lot and historically we have led the market because we want more and more and more. But I think the consumer is totally tapped out (except for government workers-who are living in la-la land as their taxpayers go broke). I am not sure how much I support tampering with the economic system, but the fact of the matter is that it is entirely possible that the majority of people in this country are underwater in their mortgages, can't refinance and can't move without recognizing a huge loss.) These folks just don't have the money to inspire any large discretionary purchases. As of yet, there is no public policy to address this issue and all political capital is being expended for what is essentially a medicare for all program--although medicare for the old is already broke.
Beyond this, unemployment will remain at these levels or higher unless there is either a huge recovery or there is a public policy change. As of now, there is no vision of job creation in this administration which is equally disturbing. Jobs are still being lost and moved to Mexico and other locations--and this will continue. As a result, we will have the real unemployment rate creep up to 20% or beyond, and the survivors will be scared that it could also happen to them. As a result, they are in a personal freeze zone of not spending. Even state and local government employees are in the same position with furloughs, paycuts and layoffs. So even the employed are running scared.
Lastly we have an administration that is talking about corporate tax increases and is creating policies that increase the cost of employment. The bottom line to this is to also constrain employment.

So I would love to be optimistic and insert alot of "maybe's" here...but I just don't see this as a normal recovery because of the public policy and financial product greed that created this meltdown. Unfortunately it will need time to find a new normal--and the governement needs to watch carefully that it doesn't artificially add to the problem just as Barney Frank and Alan Greenspan did before.

Instead a huge change in public policy is needed to encourage job creation and to encourage new industries that serve the national interest. That might include flooding the market with money in alternative energy (not merely lip service) which of course would add to domestic jobs because it would be here. No matter if solar, wind, natural gas or other methods--a real visionary stimulus would help here. Or perhaps a real public policy on transportation--massive new infrastructure projects that would also serve the national interest.

The unfortunate thing here is that we have an administration that so far has shown itself to be more interested in:
-moving prisoners from Cuba
-Cap and trade regulation
-Expanding health care for all
-increasing employee leave policies
-expanding our presence in Afghanistan


I would love to be optimistic, but I am very concerned, because we continue to have our futures determined by career politicians. The career Republicans are out, only to be replaced by the career Democrats who are just more liberal and increasingly lean toward more government control.

Unfortunately, I just don't see a case for most of your maybes!

Sep 13 08:59 PM

[Steven Hansen:]

cmbova,
well argued counter argument to my maybes. i have no dispute with anything you have written.

i believe we are currently viewing our economy too negatively - and the reality is somewhere between what you have written and what i have written.

i know writing a positive article on the economy is not popular. i originally intended this as a negative article but the facts did not support my negative view on this subject.

my purpose is to explore the possibilities. economics is not a science, and with billions of dots which make up the economic universe - it is impossible to accurately predict the future.

let me assure you, it is much easier to write a negative article as there is nothing good going on. but with everyone else telling you how bad things are - there is no balance in perspective.

we need to hope for the best, but be prepared for any eventuality.

Sep 13 09:52 PM

[Blair Dehuff:]

We keep reading a lot about a "jobless recovery." How is THAT going to work? Don't people need jobs before they can start spending again? It makes about as much sense as a "credit less" recovery, which seems to be what the FED is somehow expecting. In the short term (the next year or two) the amount of private debt still won't be paid down fast enough to get people to start borrowing again, even if they want to (a big If), and that's IF the banks will let them -- an even bigger if. As Steve points out, Boomers are unlikely to ever start borrowing again as they did in the past, unless some new credit products are invented which give them access to credit they think they will never have to pay back. Other than more innovative reverse mortgages, it's hard to imagine what such products would be.

In short I don't really see how a jobless recovery is supposed to happen, especially when consumer credit is still not flowing.

On the other hand if Wall Street can package up Pet Rocks to sell them off as bonds, I suppose anything else can happen too. Maybe it will be a smoke and mirrors "recovery" supported by lots of phony data and cooked books.

Sep 14 12:49 PM

[Steven Hansen:]

Blair, i am publishing an article today on the subject of jobless recovery.

but the same thing happened during the 2001 recession.

as long as our methods for dating recession ignores employment - crap like this will happen. what is worse it fools no one to say a recession is over when it continues.

Sep 14 07:38 PM