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Spending, Growth, and Debt
Thursday, February 02, 2006
When listening to the mainstream news media report on economic growth, the indifference with which correspondents discuss the economy's dependence on consumer spending never ceases to amaze.
Consumer spending is the largest component of GDP (Gross Domestic Product- see here and here for previous thoughts on this subject). It accounts for 70 percent of GDP in the U.S., as compared to, say, China where it contributes about 40 percent - a big difference.
What's China got more of than we do? Investment.
The change to GDP is the measure by which economic health is judged and last Friday's Q4-2005 advanced estimate of 1.1 percent annualized growth in GDP had many analysts wondering anew whether the economy needed a check-up.
Business reporters said, "The all important consumer shows signs of cutting back", or "Consumer spending, critical to economic growth, weakened last quarter..."
In and of itself, consumer spending is not bad. Consumer spending is a necessary and good thing. Only when consumer spending is too much or too little should there be concern.
How can there be too much consumer spending?
When consumer spending is enabled by too much credit and debt.
Like today. Like, when the savings rate is negative. As in the difference between income and spending - a negative number.
Where does that debt come from? That's another bit of reporting that is near and dear.
Treated with the same nonchalance as the level of consumer spending in the economic growth statistic, the financial scribblers say, "Consumers have extracted equity from their homes, enabling them to spend more than they earn", or "Taking advantage of soaring house prices, consumers have been tapping their equity and spending freely..."
Ho hum.
We're in debt up to our eyeballs, but we still have another hundred grand of equity, so what's the big deal? Very casual, not much ado, people are just "tapping equity", which by now many Americans must think is a birthright.
It's as if this is just the way things work - spending exceeds income through increased debt, and the result? A robust economy - just ask anyone in the executive branch of government, most of Congress, or nearly any economist working on Wall Street.
But, be careful who you ask on Main Street, because they're starting to grumble.
The naysayers reply, household wealth is at an all-time high - Americans are wealthier than ever before.
Yes, assets less liabilities. We've seen before how these two ebb and flow - sometimes they get out of sync.
Before stepping down, Alan Greenspan more than once commented that things are OK because so many homeowners have a significant "equity cushion". While at the same time surprised at the amount that homeowners were borrowing against their houses to fund spending, he too was largely unconcerned about the recent trend of debt-fueled consumption powering economic growth.
In fact he marveled at what he wrought.
To anyone who looks at the math, and it is nearly all addition and subtraction so it really shouldn't be that difficult, how can this be a good thing?
And, why aren't more in the news media questioning the quality of the economic growth instead of just mentioning it in passing with one eye-brow half raised?
11 comments:
People are borrowing against their houses, since the value of their houses are going up. The insanity is that the reason houses are going up is that they are considered, not just as dwelling places, but as reservoirs of equity that can be withdrawn! The more prices go up, the more prices go up.
The Really Bad Thing here that no one is talking about in the mainstream media is the cost of debt service. When interest rates were falling, the cost of servicing these equity loans, i.e., the monthly mortgage payments, were stable or falling. Now that interest rates have stabilized or are rising, the only way to get to the lump-sum equity payout is to encumber yourself with higher monthly payments. I don't think the cash flow position of the average American is good enough to withstand much more monthly expenses.
It is inevitable that a downturn will happen soon. If the Fed wants to reignite the housing fire, it will have to drop interest rates again to lower the cost of debt servicing. That will, of course, kill the US dollar and drive up the cost of imported goods. It's also an open question if, once the average American is burned by the housing explosion, and jobs start disappearing, whether they will jump back onto the housing bandwagon even with low interest rates.
My house is paid off, and I have no outstanding debt other than a .9% car loan that is due to be retired in a couple of months. I highly recommend that everyone gets out of debt as much as possible, and soon!
- Pete
All that matters is that the consumer is confident and spends money. Doesn't matter where the money comes from, what the bottom line looks like, or whether the money is being spent on anything worthwhile. All that matters is confidence and spending, confidence and spending. This all seems to mindlessly drive the world's economy today.
Pete mentioned that it's a good idea to get out of debt. I think this is almost always a sensible choice, unless you have a good safe return on your capital that's guaranteed to be better than your debt servicing costs.
My BIG fear is, though, that we are living in a Democracy (in which the Majority is supposed to rule). What happens when the Majority are in debt up to their eyeballs? Don't they influence the powers that be (like the "independent" Fed) to just keep on printing money, thus lowering the relative value of all this debt? And doesn't that work very much AGAINST the "smart" Minority like us who save?
I don't like the idea of taking my savings to the corner store in a wheelbarrow to buy a loaf of bread, but I worry that it's much more likely than getting to swoop in and buy an affordable house once the debt implosion/deflation occurs.
My 10% of savings in gold doesn't seem like enough when looked at in this light...
Love your blog, Tim -- keep it coming! -- Darcy
Don't worry, be happy; because worrying won't help after all. Too bad that Bernanke is - due to soaring commodity prices - not in the position to aid the economy and consumers with easy Al's recipe at the beginning of the new millennium.
Outstanding consumer loans for the first time in a decade are dropping since a few months but the liquidity tap is still wide open (M3.)
Where does all this excess money go?
Call me a conspiracy theorist (as long as I can call you a coincidence theorist) but I have the strong feeling that it flows right into the markets. Fed members recently stated repeatedly that asset prices were one part in their monetary policy considerations.
In the end the Fed, as any other private entity, will do what its owners say. Now, who are the owners of the Fed? Information on this is old and scarce but I guess the dominance of private banks has not changed in the last two decades. And they will fight with claws and teeth to defend the status quo. Only, I cannot bury that feeling that the huge global imbalances have run too far as that it will be possible to clean up TMTGM without a bloody trail of victims this time.
You guys should consider withdrawing some of the money from bank accounts because those non-existing lending standards will come back with vengeance. They are now even borrowing money to ILLEGAL aliens!
Many banks will simply go totally bust and things are going to be much worse than during the Great Depression.
I'm more than a little freaked out by the state of the economy right now.
Is it even possible for big Federal banks to go bust any more? In the 30's, there was a run on the banks where people demanded their money back - in that case, real money, silver and gold.
Today, couldn't the Fed just create enough money to cover a bank run? Reserve requirements are basically non-existant, so the amount of "money" on deposit at a bank really doesn't matter any more.
I still keep some silver coins and even FRNs around the house, just in case. Enough to get me out of town and to a rural area (I have some relatives out in the sticks that I could probably stay with). If things get really, really bad it's probably enough to buy a little farmette somewhere.
- Pete
Pete,
When it is said that the Fed 'creates' money out of thin air. It doesn't. It is stealing a bit from everyone who holds a dollar (a.k.a. State authorized counterfeiting). If you do this too much, people lose confidence in the dollar and you have a currency crisis. This is effectively a run on the Fed. And yes, the big banks can go bust and given enough time always do .
BTW, anyone notice how President Bush is warning auto-workers not to expect a bailout should their pensions plans fail? Meanwhile, any time there is even a hint of a financial crisis (LTCM, S&L, ...), there isn't even a debate that banking interest will be bailed out.
This is from the Daily Reckoning the other day
“One-point-one percent!”
Dr. Richebächer slammed his hand down on the table.
The recovery is as phony as the slump that came before it. During the recession, Americans refused to cut back. Now, they have nothing to recover from.
But they have nothing to recover with, either. No savings, and no new income. Unlike previous recoveries, this one saw few new jobs added. And those that have been added, have brought little to consumers’ incomes. The typical household has less money to spend now than it did two years ago.
“The whole thing is incredible,” said Dr. Richebächer. “I mean the ‘savings glut,’ and nonsense like that. It’s the kind of thing you’d expect from a Third World country, but not from America.
“You know what amazes me most is that Americans have come to believe that consequences no longer exist. They think they can do whatever they want for as long as they want...and nothing will ever go wrong.”
This is probably the first generation of Americans to believe that savings don’t matter. It is also the first generation to believe that America doesn’t really need to make anything; it can buy what it needs from abroad. But where will it get the money?
“That’s the thing,” Dr. Richebächer went on. “They think the bubble economy will never end, but bubbles always end. This one will end, too. And there will be consequences, and not very pleasant ones. This is not something the Fed can manage.
“And nowhere in America do you hear any serious discussion of the real problems involved. When I first started talking to American economists, it was back in the 1960s. We had problems back then. We thought we had problems, at least. But when I look back I realize that we had no problems that come anywhere close to the problems we face today. These problems, on an international scale, never existed before - at least not in this size. And no one talks about them. ”
Somehow, the economics profession seems to have taken leave of its senses.
That's the problem with fiat currency; some pencil-necked geek gets to decide who wins and who loses.
Prudent Investor,
It wouldn't surprise me in the least to learn that bagloads of Fed Funny Money was poured into the Market yesterday by those desperate to keep GOOG above $400.
"BTW, anyone notice how President Bush is warning auto-workers not to expect a bailout should their pensions plans fail? Meanwhile, any time there is even a hint of a financial crisis (LTCM, S&L, ...), there isn't even a debate that banking interest will be bailed out." --chubby ray
I hate to bring up the "class struggle" but the in my mind one of the main reasons that LTCM was bailed out was because basically all of the assets under management it had was the money of rich and powerful people and rich and powerful corporations (Merrill, Bear, Travelers/Salomon (now Citi), Goldman, etc.) The other consideration of course was the degree to which they were leveraged, which I do legitimately think could have created some serious repercussions on the world financial system were they allowed to go belly-up and all those positions unwound "naturally." But of course this also gave the FED a great excuse to bail out the rich and powerful investors they serve. The blue collar average Joes of GM should not expect the same treatment because they will never receive it.
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