On U.S. Consumers' Newfound Thrift

by: Elliott Gue

Regrettably, populist political theater is common in every election cycle, and 2010 will be no different. This week’s grilling of key financial executives by Congress is just the first show of the year.

One of the more persistent complaints against the banks in recent quarters has been that “greedy” bankers took bailout monies and are now refusing to lend to consumers. The idea is that banks are cutting credit lines, tightening lending standards and refusing to renegotiate mortgage terms, threatening the economic recovery.

Data on consumer credit released late last week showed credit contracting for the tenth straight month in November, the longest stretch since records began in 1943.

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Source: Bloomberg

As the chart above indicates, the contraction in consumer credit this cycle has been far more dramatic than in prior economic downturns. This data just added more fuel to claims that bankers are selfishly refusing to lend.

But the reality is that the lack of consumer lending has as much to do with consumers’ newfound thrift as it does with bank’s unwillingness to lend money. Bankers might make a convenient scapegoat for politicians looking for someone to blame for the tepid economic recovery, but major economic upheavals have historically left lasting scars on consumers’ psyches.

Consider, for example, the high savings rate that prevailed among Americans who lived through the Great Depression or Britons who lived through wartime bombings. It’s quite plausible that the American consumer, stung by excess debt during a vicious economic downturn, has less of an appetite for loans than was the case prior to the crisis.

With those painful memories fresh in consumers’ minds, aversion to debt should last well into the coming cyclical recovery. But this isn’t to say the American consumer is dead.

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Source: Bloomberg

This chart shows retail sales data for the US excluding automobile sales. As you can see, sales have been steadily recovering since the middle of 2009, albeit from extraordinarily depressed levels reached during the financial crisis.

Similarly, much has been made of the impact of last summer’s cash-for-clunkers program. But check out the chart below.

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Source: Bloomberg

There was a clear and obvious spike in US automobile sales to an annualized pace of around 14 million units in August. This was caused by auto buyers rushing to buy cars in that month to take advantage of the clunkers subsidy.

There was then an equally obvious hangover in auto sales data for the month of September; cash-for-clunkers borrowed sales from the future, and once the program ended sales collapsed back under 10 million annualized units.

But, ignoring these easily explainable effects, there is a discernable improvement in auto sales data since early 2009. Sales have recovered to 11.23 annualized units even without the benefit of cash-for-clunkers.

Consumer spending appears to be making a tepid recovery from depressed levels despite the ongoing decline in consumer credit. In effect, consumers appear to have stabilized their spending at a lower level that allows them to devote more disposable income toward repaying debt and/or accumulating savings.

If, as I expect, we get a gradual cyclical recovery in employment through 2010, consumers may also be able to boost their spending a bit further without the need to take on additional debt. This spending would be funded via higher income and would support a continued cyclical recovery.

However, although not dead, the American consumer is not and never will be the same. In prior recoveries, as consumer confidence rose debt-fueled consumption helped to lift the economy quickly out of the doldrums.

But if I’m correct about consumers’ newfound thrift, this time around we’ll see consumption rise at a slower pace than income; consumers will save some of their income and pay down debt rather than maxing out their buying power. This is one of the major reasons I expect the coming economic recovery to be tepid and shorter in duration than the average recovery during the post-war era.

There’s another implication of all this: The American consumer is acting rationally by saving more and spending less. And US lenders are also acting properly by lending more responsibly and paying more attention to the credit quality of their borrowers. After all, if it was a slew of bad loans that touched off the financial crisis, it hardly makes sense to encourage bankers to lend aggressively and create more bad loans.

The only actor in the American economy that isn’t acting responsibly is the US government. The federal government is effectively trying to restore the old world order by accelerating its own borrowing. As I’ve written in recent issues of PF Weekly, the size of total US debt is set to explode in coming years as deficits are likely to stabilize at a permanently higher level.

As I noted in the Dec. 11, 2009, issue, A Tale of Two Nations, excessive government spending and involvement in the US economy will ultimately result in higher interest rates as foreign lenders begin to demand a higher return on their investment in US Treasuries. This strategy is certain to fail in the US, just as it did for Britain in the 1970s.

More broadly, by trying to promote universal home ownership in the US, the government and its quasi-appendages Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) contributed to the inflation of the housing bubble, excessive household debt and the credit collapse. The fact that they’re once again trying to cure the recession by encouraging Americans to borrow aggressively again is pure folly and borders on the criminal.

What the world really needs is a new engine of growth that can take over from a faltering US consumer. That engine appears to be the emerging markets. Cyclical US recoveries aside, the long-term opportunities are in foreign stocks and sectors leveraged to foreign growth such as energy, technology and basic materials.

Disclosure: no positions