Consumption, Cacophony and Clarity

Includes: DIA, IVV, SPY
by: Max Fraad Wolff

Wages/salaries, wealth/savings, credit access and cost, prices of basic goods and services are all moving against the consumer. Consumption was 71% of US GDP in 1Q2008. This explains the anemic GDP growth. Investment spending by firms, government spending and net exports (exports minus imports) round out the list.

Consumption and government spending were the "positive" elements in the most recent GDP numbers. Consumption, dubiously adjusted for modest inflation, increased by 1% on a quarter over quarter basis. Government spending turned in a robust 2% rate of quarter over quarter growth. Private investment spending was negative and net exports grew as a negative number despite Dollar weakness. Things are bad and continue to worsen.

We have entered into a negative feedback causal economic loop. This is presently widely mistaken for recovery. It is no such thing. Downward leadership is simply shifting as loss begets loss and weakness begets weakness. The consumer will lead us down, as he/she led us up. In the best of times wages/salaries are good and rising, costs are low, wealth/savings are growing and credit is available and unneeded. The last year has seen escalating trouble on all fronts.

Wages/salaries and employment have been a problem for years. The 2001-2008 "economic expansion" was defined by the lowest employment and wage growth in any economic recovery since WWII. CBPP data finds job growth- now negative for five months- was less than 1% per year on average during 2001-2008. Wage and salary growth barely kept pace with under-reported inflation measures, rising on average less than 2% across the last 7 years. We enter this recession without the employment or wage growth that traditionally act to cushion a fall. Wage and employment growth did not lead the boom and they will not lead the bust. This simple fact lies behind the less than usually dramatic wage and employment deterioration. Prolonged weakness is mistaken for strength in this area.

Wealth and savings over the last 7 years have been divergent. Wealth soared while savings were non-existent. Rising home and stock prices, anemic earnings and easy credit combined to produce Great Depression levels of private savings in American households. The average annual personal savings rate in American from 2001-2006 was 1.55% and fell across the period. In the 9 quarters between 1Q2006 and 1Q2008 the real savings rate from disposable personal income averaged .45%. In other words, no savings were done.

This complicates the downturn in several ways. We have been borrowing externally. We have been selling assets and we have not been saving. Consumers enter the present fray without a savings, earnings or employment cushion and with developed world anomalous external debt repayment burdens. This ties long-term Dollar pressure to the already begun consumer problems. Thankfully for us and sadly for them, we are still allowed to borrow in and deflate our currency. Unfortunately for long term dollar bulls the coming consumer weakness here will mean large external dollar repayment out-flows.

Wealth increases were huge and heavily skewed toward the already affluent. Total assets increased 49% or $23.669 trillion between 1Q2001 and 3Q2007. Wealth peaked in the third quarter of 2007 and has been falling since. In the last 2 quarters, 4Q2007-1Q2008, assets have declined by $1.9 trillion, or 2.6%. Real estate - at market price - also peaked in 3Q2007. Between 1Q2001 and peak value in 3Q2007, real estate prices increased $8.873 trillion, or 65%. Since 3Q2007 real estate has declined in value by $426billion, or 1.9%.

We are now running in reverse with plenty further to go. Much of the loss in wealth will be invisibly removed by increasing inflation. The rest of the loss will come as asset price decline. You may be tempted to see all this as just a slight correction of inflated asset prices. I would strongly suggest the asset bubble - already deflating - needs to be judged against the debt bubble that fueled it. We came to live on "wealth." Much of this wealth was produced by debt fueled asset inflation. Much of this wealth was foreign and lent in to sustain our borrowing and spending. Thus, the already evident confluence of asset deflation and rising general price inflation creates the possibility of a perfect storm.

All those much-celebrated paper wealth gains were fueled by a borrowing binge of truly epic proportion. 1Q2001-1Q2008 household liabilities increased $6.5trillion, or 80%. Mortgage debt increased by 99%, surging by $5.3trillion to $10.6 trillion. Indebtedness has continued to rise even as the houses and equities purchased steadily fall in value. What we owe is growing, what we bought is losing value. This is the fuel of the unfolding tragedy in many households, neighborhoods and states.

It is the national economic equivalent of the mortgage-backed security crisis. Consumer earnings were flat, employment growth was negligible and borrowing soared. More debts and no more way to pay those debts created the need for endless borrowing against endlessly rising house prices. When that ended, 3Q2007, the gig was up. Firms did well. Thus, many non-financial and international businesses enter the present downturn in decent shape. However, our firms have faced no sustained wage demands, shifted health care and retirement costs toward employees, faced declining tax collections, deregulation, opening international markets and no inflation.

There really was a sweet spot. It is over. In the end, for households it really was just the bubble supporting the bubble. It will be a long fall to earth. It will be harder and harder for American families to borrow less money. This will impact firms as well. After all, it is hard to be untouched by declining consumers, loss of globalization momentum, rising inflation and falling Dollars.

Falling employment, stagnant wages, rising debt, no savings and constricted access to credit are plenty to worry about. I wish I could end there. Rising costs are the final piece of the puzzle. Energy and food prices have joined medical costs, tuitions and housing on the out of America's reach list. The newest price numbers we have are from the Bureau of Labor Statistics release on May 2008 prices. Here we learn that since May 2007 fuel oil and other fuel prices rose 50.7%, food prices rose 5.1%, dairy prices rose 11.0%, utility prices rose 11%, education costs rose 5.7%, hospital and related services rose 7.5%. All of these increases are greater than the increase in household income and most of them are massaged down through season adjustments and other gimmicks.

Through the cacophony of reassurance and gyrating reports, America's true economic tone is very sad. Strong government spending and low-ball inflation numbers kept our recent quarterly GDP numbers above water. Our government has been spending far too much for far too long. Uncle Sam long ago came to rely on foreign creditors who are standing by holding declining dollar assets paying less than their national and our national inflation levels. Thus, it will be hard to use government spending, like we did last quarter, to push GDP above water.

Much like it has been hard for financial firms to move losses forward while waiting/praying to be bailed out by growth, so too will the state have problems. Foreign borrowing, inflation numbers and payment requirements on all that foreign borrowed debt stand as a challenge to long-term, Dollar bulls.

We have been down before and got back up. I believe we still have it in us. I don't believe that it is possible without admitting the situation and making major changes. I would also caution those who see American weakness - 20% of world GDP - as isolated or contained. Thus, America's relative position is far less poor than our absolute position. Like the housing securitization crisis, our present macro-structural problems will ramify globally.

We may be at the end of the beginning of these processes; we are not at the beginning of the end of them.

Disclosure: None