“The Coming US Consumption Bust”, by Nouriel Roubini
A nice summary of the current situation. Professor Roubini is far more optimistic than I. That’s said with trepidation, as economic forecasting is among the most difficult of human endeavors.
“The Coming US Consumption Bust: 12 Reasons Why the US Consumer is in Serious Trouble and Faltering“, Nouriel Roubini (wikipedia bio), RGE Monitor, 3 September 2008 — Reposted here in full, with permission.
It is by now clear that the shopped-out, saving-less and debt-burdened US consumer is on the ropes and that there will be a significant and persistent contraction of real consumption for the next few quarters. About a dozen separate negative headwinds – to be described in detail in this note – are now hitting the US consumer while the positive effects on consumption of the tax rebates are already fading away.
That rebate boost was supposed to stimulate consumption until August of this year instead after a recovery of retail sales, real personal spending and consumption in April and May real retail sales and real personal consumption spending have fallen already in June and July. So consumers stopped consuming in spite of the tax rebates instead of spending such rebates (so far only 30% of them have been spent). This suggests that real consumption will certainly fall in Q3 and will continue to fall for a while into the middle of 2009. Real consumption did not fall in the 2001 recession and you have to go back to the 1990-91 recession to see a single quarter of negative consumption growth.
Why will consumption keep on falling for quite a while? There are at least a dozen separate factors explaining why we will now see a sharp and persistent fall in real consumption:
(1) US consumers are shopped out and saving-less; the low savings rate of the US household sector fell almost into negative territory as the positive wealth effect of rising home prices – until 2006 – led to overspending. Now a retrenchment of consumption and rise in savings is necessary
(2) Home prices are now falling and therefore households cannot use their homes as ATM machines – like until 2006 – and borrow against it to spend more than their income. Recent studies suggest that the wealth effect of housing on consumption is large, larger than previously estimated (closer to 12-14 cents on the dollar rather than 5-7 cents on the dollar)
(3) Home equity withdrawal (HEW) that peaked at $700 billion in 2005 is now down to about $24 billion (practically zero). And financial institutions are sharply cutting back on outstanding home equity loan obligations. Thus, borrowing against housing wealth is now collapsing. Even with moderate estimates of HEW effects on consumption (25 cents on the dollar rather than the 50 cents on the dollar estimated by Greenspan and Kennedy)
(4) There is an additional wealth effect of the stock market on consumption; and with major indices down almost 20% from peak this is an additional effect.
(5) The increasing credit crunch is spreading – based on various surveys – from subprime to near prime and prime mortgages, to home equity loans and now to credit cards, auto loans and student loans. So the price of credit/borrowing is rising while its quantity is falling and this will reduce the ability and willingness of households to borrow to spend.
(6) Debt ratios for the household sector are high and rising: the debt to disposable income ratio for average US households has increased from 100% in 2000 to almost 140% today.
(7) Not only debt ratios are high but debt servicing ratios are high and rising for households given the reset of interest rates to higher levels on mortgages, credit cards, autos loans, student loans and other consumer credit.
(8) Even after the recent fall in oil and commodity prices from their peaks such prices are about 50% higher than a year ago and 300% higher than six years ago. For any given income, rising oil, energy, transportation and food prices implies a reduction in real disposable income that erodes purchasing power. And lower income households have a larger share of their consumption basket going to food, energy, heating, transportation and gasoline; this the rise in commodity prices erodes their purchasing power more than for higher income individuals.
(9) Nominal and real wage growth has been anemic in the last few quarters and slowing down over time. Thus, real incomes – especially for workers – are not rising significantly.
(10) While GDP growth in Q2 has been robust (3.3%) the other measure of output – on the income side rather than on the demand side – that is the Gross Domestic Income (GDI) has been very weak (growing only 1.9% in Q2 and falling relative to Q2 of a year ago). So measures of income growth – and not that the gap between GDP and GDI has been rising over time for complex statistical reasons – suggest very anemic income growth that is bearish for consumption.
(11) Consumer confidence is sharply down and close to levels we have not seen since the two 1970s stagflation episodes.
(12) Now the last factor – job generation – that was supporting consumption in spite of the headwinds described above is faltering: employment in the private sector has fallen for 8 months in a row; and overall employment (including public one) has fallen for 7 months in the row). And other indicators of the labor market suggest persistent and continued weakness.
The 12 negative headwinds described above are significant and persistent while the only positive factor supporting consumption – the $100 billion of tax rebates – was temporary to begin with and failed to boost consumption even over the horizon (through all of Q3 of 2008) over which it was supposed to have an effect: consumption started to fall in real terms already in the latter part of Q2 (in June of 2008). And with consumption being 70% of aggregate demand the effect of such a fall in consumption (until at least Q2 of 2009) on GDP growth will be more severe and persistent.
Thus, expect to see a contraction of GDP in quarterly figures already in Q3 of this year and all the way until the middle of 2009. Since the US recession started in Q1 of this year (based on the five indicators used by the NBER) the 18 month U-shaped recession will be a W-shaped recession given the blip in GDP in Q2 following the tax rebates and an unsustainable improvement in net exports. So we will observe a double-dip W-shaped recession.
The improvement in net exports is not sustainable because the view that the rest of the world would rescue the US from a recession through a boom of US exports is now challenged by two major factors: the US recession is spreading to all of the G7 and almost all of the advanced economies (representing 55% of global GDP); and since US exports are the imports of Europe, Japan, Canada, etc. the fall in these economies will slow down their imports of US goods. Second, the recent strengthening of the US – as the G7 are slumping into a recession – will reduce the improvement of the US trade deficit.
A shopped-out, saving-less and debt-burdened US consumer is now stretched like never before, at its tipping point and starting to falter and contract spending. Since we have not seen a fall in consumption – even for a single quarter – for the last 18 years the effects of this sharp retrenchment of US consumption will be severe and cause a protracted and sharp US recession, at least a 18 months recession rather than the 6 months recession predicted by a delusional economic consensus.
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For more information about this subject
A brief note on the US Dollar. Is this like August 1914? (8 November 2007) — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
The post-WWII geopolitical regime is dying. Chapter One (21 November 2007) — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
We have been warned. Death of the post-WWII geopolitical regime, Chapter II (28 November 2007) — A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).
Death of the post-WWII geopolitical regime, III – death by debt (8 January 2008) – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
Geopolitical implications of the current economic downturn (24 January 2008) – How will this recession end? With re-balancing of the global economy, so that the US goods and services are again competitive. No more trade deficit, and we can pay out debts.
- A happy ending to the current economic recession (12 February 2008) – The political actions which might end this downturn, and their long-term implications.
- What will America look like after this recession? (18 March 208) — More forecasts. The recession might change so many things, from the distribution of wealth within the US to the ranking of global powers.
The most important story in this week’s newspapers (22 May 2008) — How solvent is the US government? They report the facts to us every year.
To see the all posts on this subject, go to the archive for The End of the Post-WWII Geopolitical Regime.