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Evidence of an Optimistic Extreme


My late grandfather was 10 years old when the Great Depression began. The hardships he and others witnessed influenced their consumption patterns for their entire lives. The generation that grew up during the Great Depression saved heavily and loathed debt, for they knew the consequences when hard times hit. Today’s generation of youngsters are likely to learn some of the same lessons as my grandfather’s generation did, based on today’s optimistic extremes in debt and consumption as well as the lack of savings.

Let’s start with the conclusion: People have been extremely optimistic, so they have consumed much and saved little. They have been so optimistic that they have financed their consumption with debt rather than savings, something my grandparents would NEVER have considered. Now it seems that these trends are about to reverse, and here’s the evidence:

1.       Consumption/GDP - Realize that there’s a positive feedback mechanism at work here, because the more that gets consumed, the higher GDP goes, and vice versa. From the low in 1978, slightly below 62%, we can count five waves up (chart courtesy David Rosenberg, At the very least, it seems that consumption as a share of GDP should decline to 68%, but it’s likely to head back down to the 61%-64% area, which is likely a larger fourth wave. Now, contrary to popular belief, consumption is not how a country becomes wealthy; wealth is, in fact, destroyed by consuming. This is especially true when the consumption is financed from debt  rather than savings, since debt is a claim on future consumption.

2.       Household debt and disposable income - Notice that the two were about the same back in the late 1990s even as an equity bubble was under way (chart from St. Louis Federal Reserve). But as we can see, from late 2001 through 2007, consumers took on debt that dwarfed the growth in disposable income. Even though household debt levels have fallen since 2007, the imbalance is still quite substantial.

3.       Savings rate and debt’s rate of change
– It’s common knowledge that total savings rates have declined for decades until recently. But here we see savings as a percent of disposable income. Note that it actually turned up back in 2004. It’s also common knowledge that household debt has fallen since 2007 as consumers tighten their belts, but this chart shows that debt’s growth rate relative to disposable income topped in 2004. In other words, attitudes towards saving and debt turned long before the economy turned down. This fact speaks to the large-degree shift from optimism to pessimism that’s under way.

Generation X, those born between 1965 and 1981, has witnessed only relatively good economic times. The same goes for the Baby Boom generation with minor exceptions (’62, ’69-’70, ’73-’74 and ’81-’82). It’s difficult to imagine that consumption/GDP and debt/income could ever reach more optimistic extremes than they have already registered. Our big-picture Elliott wave counts say that they have one way to go – down. Although the government is likely to attempt to fight these reversals, people will mostly acquiesce to the new downtrend in social mood until a far different pessimistic extreme is realized. Interestingly, youngsters today will likely learn my grandfather’s frugal economic behavior, rather than their parents’ spendthrift ways, and retain it for their entire lives.

Jason S. Farkas, CMT

Disclosure: No positions