Unstoppable Collapse In Aggregate Demand

Includes: SJM
by: Jason Tillberg

You can give a guy $8,000 if he buys his first home, but you can't make him buy it. You can make interest rates 0% for banks, but you can't make them lend it.

There are simply limitations to what you can expect when you try to induce people to do something they may not want to do.

In Ben Bernanke's November of 2002 Helicopter Speech titled: "Deflation: Making Sure it Doesn't Happen Here", he hints on what the Fed would do in the event of falling prices.

First off, why does Mr. Bernanke think falling prices are bad? He cites Japan in his speech with the following characteristics:

That this concern is not purely hypothetical is brought home to us whenever we read newspaper reports about Japan, where what seems to be a relatively moderate deflation--a decline in consumer prices of about 1 percent per year--has been associated with years of painfully slow growth, rising joblessness, and apparently intractable financial problems in the banking and corporate sectors.

So Mr. Bernanke warns of deflation as leading to painfully slow growth, rising joblessness and financial problems. The opposite of deflation or falling prices would be inflation or rising prices.

Mr. Bernanke goes on to say the following about the causes of deflation:

The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand--a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending--namely, recession, rising unemployment, and financial stress.

Mr. Bernanke poses some cures for stimulating demand, even if the Central Bank's policy rate has fallen to Zero, which is where it has been since the end of 2008. (Chart further below) He writes the following:

As I have mentioned, some observers have concluded that when the central bank's policy rate falls to zero--its practical minimum--monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken.

He wrote those words back in 2002 and has now had his chance to prove it.

What he felt the Fed could do was lower interest rates of longer-term securities via policy measures mainly consisting of buying assets like treasury bonds or other assets like mortgage-backed securities with money created on its "electronic printing press."

Here is a chart of the interest rates of various dated treasury securities since 2007. Click to enlarge

He's most definitely keeping his word and following his logic.

For perspective, here is a chart of inflation and deflation in the U.S. since 1872:

Click to enlarge

Deflation certainly adds risk to banks failing. In 1933 alone, 4000 banks failed and a total of 9000 banks failed in the decade of the 1930s. Source: pg. 9

The problem is, today, there is so much debt and leverage, the slightest bit of contraction in loan demand or new loans that help to repay the old loans, could at some point trigger a collapse as A can't pay back B and then B can't pay back C and then C can't pay back D and so forth.

Here is a chart of total credit owed in the U.S. This includes government debt, business debt and consumer debt all together.

Click to enlarge

When I crunch the numbers to come up with this debt as a percent of GDP, I get the following:

Click to enlarge

The peak was in Q1 of 2009 at 385.78%. In Q1 2012, it is 353.20% or the same level as Q3 2007 only.

This is a giant balancing act of trying to deleverage this debt without causing a collapse. Hence the constant bailouts and QE measures by the global central banks that don't seem to be letting up. If the weight of collapse exceeds the rate of bailouts, things could get ugly quickly I'm afraid.

Having a growing economy helps to make this deleveraging easier. If the economy slows down, coupled with attempting to deleverage all this debt, we set ourselves up for defaults again like in 2008/2009.

What's a growing economy? Growing aggregate demand most preferably. After all, economy is defined as the production and consumption in a given region or country. As Mr. Bernanke stated in his speech, deflation is a collapse in aggregate demand and he laid out all the tools he would use to prevent a collapse in aggregate demand.

I would argue today that we are seeing a collapse in aggregate demand and unlike what Mr. Bernanke said it was mistaken to think that if the fed funds rate were to fall to 0%, monetary policy would lose its ability to stimulate aggregate demand.

He's done all he said he would do yet we continue to see drops in aggregate demand all over the place with either minimal recoveries or continued declines.

Let's start with Total Oil consumption in the U.S.:

Total Miles driven on roads in U.S. per capita:

Click to enlarge

Despite aggregate demand falling for gasoline in the U.S. as we're driving less, the price of gasoline has remained very high over the last few years, which begs the question, what would gas prices be if aggregate demand were to rise in the U.S?

Here is a chart of the price of regular gasoline:

Click to enlarge

JM Smucker (NYSE:SJM) just reported earnings and when discussing their coffee line, noted the following:

The U.S. Retail Coffee segment net sales increased 7 percent in the fourth quarter of 2012, compared to the fourth quarter of 2011, including the realization of higher price. The acquisition of Rowland Coffee contributed approximately $24.0 million to segment net sales, representing 5 percentage points of the segment net sales increase. Segment volume decreased 8 percent for the fourth quarter of 2012, compared to the fourth quarter of 2011, excluding Rowland Coffee. Volume declined 7 percent for the Folgers® brand and 13 percent for Dunkin' Donuts® packaged coffee.

No deflation in the price of coffee, rather, inflation or price increases, but that is causing volume demand to tank 7% for Foldgers, (That's what I drink) and 13% for Dunkin Donuts coffee. Mr. Bernanke said in his speech it was falling prices at a consequence of falling demand.
The good news for JM Smucker at least is its profits are up 13% year over year. President Obama was surely right when he recently said the private sector was doing just fine.

Passenger Vehicle Registrations:

Click to enlarge

Housing Starts:

Click to enlarge

Meat consumption per capita in the U.S.:

I would also argue that a large factor of what has happened in the U.S. economy has been a major contraction to the percent of people who are employed relative to the total population. Perhaps this is simply a correction and a normal regression to the mean. Perhaps this should not be fought with potentially dangerous tools like money printing.

Here is the chart of civilian employment to population ratio:

Click to enlarge

With a population of 313 million in the U.S. today, for every 1% change in this ratio is equal to 3.13 million jobs. Throughout the 1950s and 1960s, this ratio ranged between 55% and 58%. It soared all the way to 64.5% in 2000 at its peak. Baby boomers were born between 1947 and 1963 making them between the ages of 37 and 53 in the year 2000. A prime age to both be working, spending and earning high incomes at that time of their careers. Also worth noting is that the U.S. dollar was very strong in 2000 and oil prices close to $10 a barrel.

Today, baby boomers are 49 to 65, in savings mode and retiring.

Here is the same chart going back just 5 years:

Click to enlarge

If the percent of the population working reverts back to the same levels as in the 1950s and 1960s, roughly 55%- 58%, we could be looking at another leg down of jobs being lost - to the tune of up to 10 million if it goes back to 55%.

Despite all the efforts by the Fed to stimulate aggregate demand, while making sure "deflation didn't happen here" via monetary policy, aggregate demand for goods is either growing slowly or has continued to drop. Perhaps it's an unstoppable collapse?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.