A Rational Consumer = Bad News for the U.S. Economy

Virtually all talk of a possible recession and future recovery hinges on the American consumer. The reason for this is well known. Consumers account for 2\3 of the economy. The problem, however, is that consumers may be "spent". According to the Federal Reserve Board [FRB], consumer credit has risen by $1 trillion in the last 7 years. That number has two parts, revolving (think credit cards) and non-revolving (think auto or furniture loans) debt mostly incurred for consumption. In fact, based on current trends we are on track to see consumer debt increase from $1.54 trillion at the beginning of the decade to more than $3 trillion at the end of it-a nice double. I know this is boring stuff already beat to death, but facts is facts.

There is a hypothesis about the 2008 economic outlook that you can hear repeated hourly on CNBC by some four-star guest commentators, and you can read it daily in the business press. Generally, it goes something like this; "we see weakness in the first half followed by a pick up in the second half of the year." In fact, Chairman Bernanke just about repeated that exact statement in his testimony to Congress today. He also told Congress to hurry up and mail some checks to consumers ASAP (aka "fiscal stimulus") and assumed that 65% of any stimulus would be spent rather than (oh my god!) saved. So, beyond this check-mailing scheme, I have a question. Why exactly would things pick up in the second half of the year or even in 1 year?

If you are going to answer my question, I want an adult reason. Ok, I better explain that one. I have a 3-year old and recently my wife and I have begun asking her to explain her own bad behavior. The exchange usually goes like this:

Mommy: "Sweetheart, why did you throw your food on the floor?"

Daughter: "Because"

Mommy: "Because is not a reason"

Daughter: "Yes it is. Because is a reason."

So, the point is that I want a well-reasoned answer. I don't want to hear an adult version of "because" which is what I hear too often. Sometimes "because" is disguised, but don't be fooled, most answers offer no solid reasoning. Here are the canned answers I see and hear repeatedly to the question of why the economy will pick up in the second half:

Because you just can't count out the American Consumer. We think this housing and credit crisis will stabilize, banks will begin lending again and consumer confidence will return. When that happens, spending will pick up.

Its an election year and traditionally as we get closer to the election, spending will pick up.

The American economy is resilient, we always bounce back and when we do spending will pick up.

Every answer seems to always end with "spending will pick up" There is, however, a lot missing from most discussions and a lot of assumptions seem baked in, the least of which is the consumer's ability and willingness to take on ever more debt. In all seriousness, an answer that would have accurately predicted the recovery from the last recession would have gone like this:

We will enjoy a recovery when the Fed lowers interest rates to effectively 0% which will allow ponzi-scheme securitizations of unprecedented amounts of loans to borrowers qualified based on their ability to sign their name. This credit bubble will then inflate home values up to 300% in the next 4 years which will allow for massive equity extraction. Couple that with an increase in consumer debt of $1trillion and you will see a recover that will drive the economy through 2007.

Yes, I know, there were some productivity gains too, but aren't we all fully wired at this point? The problem is that a lot of printed and spoken commentary is by people who MUST go long the stock market and to do that you MUST promote the consumer. Most managers must buy equities. If the consumer dies, their income dies. They are always going to promote the resiliency of the consumer and pick a not to distant point in which the consumer will come "roaring back." "We will enjoy a recovery in the second half," sounds so reasonable and close enough in time that investors may hang tough and not completely abandon the market.

Promoting the consumer, however, is getting harder and harder. Debt as a ratio of disposable income is already at about 14.5%, which is a record. I am just wondering at what point the constant increase in debt load becomes unbearable. Is it possible that after seeing their friends and family collapse under the burden of irresponsible debt, their home values deflate by trillions of dollars, and now the stock market go pop, that the American consumer would take a few years (not months) off and NOT spend beyond their means? Is rational behavior by the American consumer even possible? If it is, we are all in trouble.

Comments

[deano:]

You are the first financial pundit I have heard/read that actually makes sense. In a country where there is a negative savings rate, we are cheering the consumer on to spend more. The wealthy (investors) getting wealthier on the backs of the middle class (consumer).

2008 Jan 18 09:36 AM

[David Roskoph:]

It's embarrassing to hear our Treasury Secretary promote perpetual irresponsibility. Run money to citizens so they can spend it - is this what we teach our children? It is why we are here and will collapse before we figure it out. We've institutionalized overconsumption and we are now completely dependent upon sucking every cent out of the masses far into the future. Now consumers are so tapped out a bankrupt government plans to send them a check so we can pretend we're growing? This is insanity The days of America's gratness are behind us because we would rather indenture our grandchildren than bear any inconvenience, or forestall the purchase of more junk!

2008 Jan 18 01:12 PM

[Pauper:]

irrational exuberance has always been a problem for investors. the real estate market is just as big of a joke as the dot.com bubble, but people still make stupid arguments that go something like this: "yeah, well at least you can live in your house." hmm, ok. so you can live in the house for which you overpaid and hope that someday, maybe 10 years from how, you will be able to unload at the buying price. good choice! consumers will continue to spend, no doubt about it, but will it be enough to butress the economy? no, probably not.

2008 Jan 19 11:26 AM