Green shoots and leaves? Or a false spring?

July 14, 2009 at 6:09 pm | Posted in economics, recession, saving | Leave a comment
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The economy is in recession partly because the consumer is fearful.  The consumer is afraid of the high level of debt as well as of falling networth (retirement, real / investment asset prices) and also afraid of job loss. The correct private response to these fears is to cut back spending to deleverage, boost assets/networth by fresh savings / investment and to build a short term savings buffer as unemployment self-insurance. The means of doing this is by cutting back on discretionary spending to generate or increase a cash flow surplus, and put that to work to achieve these private objectives. However, given that private debt is such a large part of income, it will take a long time to realign.

Suppose someone wants to build an additional savings buffer of 6-months of must-spend expenses… pretty reasonable, I’d say, and not something that would fundamentally improve their balance sheet, so they really need to do more… Take an average family with $50k household income. Given that they are probably taking home about 80% of their pay ($40k) after taxes, and spending about 95%+ of their take home, and assume that 75% of their expenses are non-discretionary ($30k), they would need to save $15k to achieve that 6-month goal. Since only 20-25% of their spending is discretionary, even if they cut that to zero (highly unrealistic) it would take 18 months to achieve this objective. Clearly, then, spending alone is not enough. But right now, raising incomes to meet this goal is just as unrealistic, on average!

This $15k savings goal for an average family translates to $1.7 trillion for all US households – $1.7 trillion of reduced consumer spending. I think the true savings goal to restore private fiscal health is way greater than this.  So the stimulus is not enough. No way. Not even close.

The public impact of the collective private actions is this: Everyone is cutting back, and is willing to work longer hours / grow productivity just to keep their job. People are even willing to take pay cuts to avoid layoffs ( you kept the job, but your nominal debt is the same, real debt has increased because nominal and real wages went down). As a collective, that sucks because the economy needs to deleverage even more with a lower income base to do it – debt to income just went up a notch. That means demand for discretionary goods and services is way down, will stay down for a long time, and, when it begins to recover, the incremental demand will be met for a long time from existing employment, so this will be a jobless recovery when it recovers. In the meantime, note that the growth in unemployment is only about 5-6% points so far i.e. unemployment has not risen fast enough to account for higher productivity and the lower demand that has occurred and will continue to impact the economy. This means there is a lot of “dry powder” left in productivity gains for when the recovery does happen.

The economy is 65% consumer, and the rest is enterprise spending to create capacity to meet consumer demand. A lot of export markets are in worse shape than the US.

I think this is a false spring. We may not drop back into the depths of winter, but the real spring lies on the other side of a few bad cold spells – enough to wither the green shoots.

Stay cautious. Stay pessimistic.

An unusual recession?

March 20, 2009 at 1:05 pm | Posted in economics, Housing, recession | Leave a comment
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Usually, in a recession, there are people who suffer – people who lose jobs or have their hours cut… Others see the value of their investments fall as well. However, for the majority of people, life goes on as usual. They may cut back a bit, may feel the impact of the markets on their portfolio, but most people don’t have too large a portfolio, especially outside of a 401(k) or IRA, so the impact isn’t immediate. Yes, the 401(k) is down, but it’ll recover by the time I need the money seems to be the mantra.

What may be unusual about this recession is that everybody is hurting. You cannot be complacent about a “safe” job when you have suffered anything from 30% (for those with no or almost paid-off mortgages) to 75% or even greater than 100% loss of equity in your greatest asset – your home.

This is not an event that has happened to some of your neighbors and you hope does not happen to you.  You may still have your job, you may be years from retirement – but the recession has already hurt you – and me, and all of us.

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