Robert Loftus'  Instablog

 One of the common tropes of economists is that "Credit Creates Demand".  I claim that credit only creates demand under very unique circumstances-and Consumer Credit is not always a creator of demand.  The "Dollar Multiplier Effect" touted by Keynesians is attenuated by current prominent business models that allow retailers to sell to developed world consumers without having to pay developed world wage rates for manufacturing labor.  Absent conditions sympathetic to a "Dollar Multiplier Effect", Credit is not a universal creator of demand, but only a vehicle of existing and pending demand.  While extension of credit to consumers may create a momentary appearance of demand in consumer markets, that appearance is illusory, and will eventually result in a "demand trough" as we've seen recently with the housing market.  This phenomenon has broad implications for consumer behavior and government policy. 

When credit is merely a means for consumers to purchase goods, and those goods are frequently of questionable quality and are designed to have a limited useful lifespan, the social utility derived from economic transactions is essentially null. Keynesians may argue that the "dollar multiplier" effect stimulates dollar velocity throughout the economy, but this argument is also invalid.   When the majority of productive work that goes into the manufacturing of goods is done in foreign markets and the administration of retail functions is done remotely-as in a big box store where the majority of funds for sales are siphoned back to a central management and supply office-there is little to no community wealth or-for the Keynesians-"Dollar Multiplier Effect" derived from consumer sales at the community level.  The business models employed by many large retailers do not provide the kind of geometric economic growth dreamed of by economists, but may even act as siphons-sucking wealth out of the communities those stores inhabit.  

Without the benefit of a Community Wealth (or "Multiplier") Effect consumer transactions don't effectively contribute to the public weal, and credit is not a creator of demand, but only a vehicle of existing and pending demand. Credit has the potential to accelerate consumer demand periodically, but that periodic acceleration in demand will inevitably lead to a trough in future demand for the simple reason that use of credit instruments demands fulfillment of debt maintenance obligations in order to preserve credit market equilibrium.  Interest paid on debt maintenance obligations also goes to non-local markets and ends up mitigating any local benefits from the use of credit instruments-thereby actually reducing total potential economic demand at the community level, and leading to a general reduction in dollar velocity at that community, or "Main Street" market level.  

This post is the first in what will be a series of posts discussing various aspects of the use of credit. 

  



Disclosure: No positions

    All evidence is pointing at a downward trend in home prices following the cessation of the Home Buyer tax credit.  Recent news of a 0.6% uptick in housing prices is likely a result of this phenomenon.  Traditional notions of home ownership as a public good that helps to prevent urban decay have become out-dated in an environment where out-sourcing of jobs and continuous cut-backs in employment by cash-strapped States mean that the average working American has no way of knowing what his or her employment prospects will be in another two to three years.  

    Those familiar with my comments on SA know that I have been predicting for some time that housing prices still have a long way to fall, and that we're likely to see Case Schiller ratings of 90 to 110 in the majority of major RE markets before too much longer.  Given an unemployment rate that remains stubbornly high, a figure which will be aggravated by large numbers of unemployed college graduates over the course of the next month, potential employers are still able to Cherry-Pick applicants, and do not have to offer anywhere near the kind of compensation that they might have to in a competitive employment environment.  Also, just because the economy does appear to be improving marginally does not mean that we will see an automatic end to all efforts to out-source professional positions-such as engineering and software programming positions-to India or China.  There is also another factor-which I've stated repeatedly-that the generations succeeding the Baby Boomers aren't likely to have the financial wherewithal to acquire the assets of the Baby Boomer generation, which means as Baby Boomers start down-sizing and trying to create a simpler lifestyle that they will be better able to keep up with in their older years, many will take significant financial losses as they liquidate assets-including homes-that they've acquired over the years.  

    The points cited above point to one of the greatest problems with Real Estate-it's obvious lack of portability.  The traditional notion of home ownership as a public good that helps to prevent urban and suburban blight is out-moded in a society facing the employment conditions cited above.  It is foolish to expect average working Americans to fall on their swords for the benefit of the mayor and school-board.  A more successful approach to Real Estate would identify the needs of working people and would seek to address those concerns through the proper application of market forces rather than a myriad of government programs and subsidies.  A massive conversion of single family homes to duplex and triplex rental units could help to stabilize RE markets. 

    Price stability in RE markets is only likely to come when prices have fallen to the point where potential landlords see a significant prospect for financial return via the acquisition of residential properties, and the conversion of those properties to rentable space.  This transition will likely include the conversion of many McMansion properties to duplex and triplex uses, so that landlords are able to offer more realistic rental rates for those properties.  This transition will likely produce an enormous NIMBY response as many municipalities will face the decision of whether to allow duplex and triplex use and thereby enhance the transition of empty homes to income generating properties, or insist upon single family dwellings and eventually see massive property devaluation, empty homes, and expanding property tax seizures.   

    The transition away from traditional notions of home ownership to a more flexible rental based RE market is the only way to serve the housing needs of the American public, given volatility in employment, it is not realistic to assume that so many Americans will continue to purchase homes with mortgages that they may only be 7 to 10 years into paying off before they have to move again, or have to live with the continual specter of default because of job loss due to out-sourcing or state job cut-backs.  In a time when the best advice you can give to a young person considering different careers is to select a field where the work is done in person-doctor, nurse, teacher, etc-so your job can't be out-sourced to China or India, a more flexible approach to the management of RE is absolutely essential.  


Disclosure: No Positions

 I like to walk around and observe consumers in various retail venues.  I also regularly engage in conversations with shop clerks to find out about customer behaviors that they've been able to observe.  The shopping habits of American consumers appear to be changing rapidly, and the long term implications of these behavioral changes are great.  

During the height of the Real Estate boom many Americans were bolstered financially by fantasies of continuously appreciating homes and home equity lines of credit. Now that real estate prices are falling, many are facing the reality that they are much smaller fish than they had previously imagined.  That realization brings along an assortment of changes in consumer behavior.  

The Growth of Second Hand Retail

Many Americans seem to have a growing resentment against imported goods. Those resentments seem to extend to those retailers that import the majority of the goods they sell.  Judging by the amount of business I've observed recently at Salvation Army and Thrifty Shopper stores, along with the incredible amount of traffic I've been able to observe at local Flea Markets, it appears that many are intent on keeping as many of their dollars as possible at the local level.  Significant growth in second hand retail will be largely dependent upon what happens with health care reform.  The current pool system used by health insurers favors large employers over small business owners.  If health care reform passes it will level the playing field for small business owners and we are likely to see massive growth in the second hand goods trade.  This is positive for the country as a whole as it can lead to a significant increase in dollar velocity at the community level, and obviate the need for such ill-conceived strategies as "Krugman's Tariff".  Consumers opting to forgo imported goods in favor of second-hand items for many of their non-perishable purchases is something that can slip under the radar, while significantly reducing China's influence on the American economy.  Government policies that direct punitive tariffs at foreign countries could spark the same kind of trade conflicts that followed enactment of the Smoot-Hawley tariffs and led to a significant deepening of the Depression. 

The "Made in America or $1" Mentality

American Consumers' resentment of imported goods does seem to have one area of compromise-goods priced at $1.00.  I'll provide an example: Consumer A needs to purchase a screwdriver.  He goes to the tool department of a local hardware store and finds three screwdrivers of the size and type he needs to purchase at three different price points.  Screwdriver 1 is priced at $1.00, is made in China and obviously of low quality, and is located in the Discount Tools bin at the front of the store.  Screwdriver 2 is priced at $3.99, appears to be of far better quality than the $1.00 tool, but not as well made as the $7.99 tool, is also imported from China, and is shelved with the line of consumer brand tools that store carries. Screwdriver 3 is $7.99, has a "Made in the USA" logo on the packaging, and comes with a lifetime replacement guarantee.  Based on my conversations with consumers, it appears that most consumers would either purchase the $1.00 screwdriver-and not worry about it being made in China because it's only $1.00, or they would go for the $7.99 tool that's made in the USA.  The $3.99 screwdriver, which according to typical economic figuring would be a good compromise regarding cost and quality isn't even considered, the item may as well not even exist.  

The changes in behavior described above seem to be largely defensive in nature.  Now that many American consumers realize they aren't nearly as affluent as they once thought, they seem to be adopting behaviors that, while influenced by some degree of Consumer Nationalism, are primarily aimed at their own economic survival.  The "Old Days" of consumers running up their credit cards with cart-loads of imported merchandise from Suburban Big-Box retail stores may be over and done.  It will be interesting to see how retailers in our consumer driven economy adapt to these changes. 



Disclosure: No Positions