3 Reasons the U.S. Economy Remains in a Coma
Mortimer B. Zuckerman
The triple whammy of poor consumer sales, a weak housing market, and high unemployment, along with excessive debt are dragging down the recovery
There's an acidic remark by Dorothy Parker, the New Yorker wit of the 1920s, that just about sums up our present economic predicament. She was asked if she'd heard the news that President Calvin Coolidge was dead and responded: "How can they tell?"
How can we tell that our long-awaited recovery is alive? Once the pulse began to beat a little more strongly last year, it was assumed that we were on course to something like full health. Attention has been focused recently on the various deficits, the debt ceiling, and the budget battles. They're all matters of concern, but all of them will be more menacing if the nascent recovery is stalled or reversed. Is that happening? Or are we on an ascent at last, with 192,000 new jobs added to nonfarm rolls last month?
Three elements offer clues: consumer spending, housing, and unemployment.
The bubble of exuberant consumerism that powered the U.S. economy for the last 10 years of the 20th century and most of the first years of this century has burst. In reaction to economic hard times, American consumers are planning for the worst rather than hoping for the best. Their spending patterns and behavior have changed. In the middle of 2008, spending dropped below disposable incomes, and it has not improved much since then.
Who could blame people for holding back when 50 million Americans rely on taxpayer-supported programs, whether food stamps or unemployment benefits. This downturn may not have the 1930s feel of despair, but in large part that is because, as economist David Rosenberg of investment firm Gluskin Sheff put it, "The modern day soup line is a check in the mail."
As evidence of their anxieties, an unprecedented number of Americans are borrowing against their 401(k)s, canceling their life insurance policies, and forgoing physicals. Only the wealthiest 10 percent of the population, whose stock portfolios have come roaring back, are doing well, but their spending is not enough to spur the economy or create much additional hiring. The rest of America is still caught up in the Great Recession.
And that isn't all.
The American consumer is fearful of the impact of higher food prices, higher gasoline prices, higher interest rates, higher everything. The inflation in food and fuel alone has absorbed the December tax cuts agreed to by Congress and the administration. Higher bills for gasoline and home fuel will suppress U.S. household spending power to the tune of $60 billion a year, according to Rosenberg. Surging grain and meat prices are going to lift the grocery bill by over $40 billion. Add to that $100 billion of drainage from disposable income as a result of the end of various debt service relief programs and higher interest rates. Altogether, American consumers this year are facing over $200 billion of headwinds.
According to The Week magazine, 93 percent of consumers have changed their spending habits, pursuing lower prices and waiting until items are heavily discounted before purchasing. In fact, in 2009 we had the first spending decline on record for people in all income groups. The underlying trend in organic real final sales remains in the range of 1 percent. Both auto sales and housing sales should be running at a rate 50 percent higher than they are. They are the most correlated with interest rates and the availability of credit, and these financing costs have been at record low levels.
So where has the recent modest growth in the economy come from?
It is primarily due to massive amounts of federal stimulus and a big swing in inventory, and the impact of both will peter out this year.
Why are all the vital signs discouraging?
Quite simply, because households are still carrying far too much debt. Relative to income, debt today is approximately twice as high for families as it was about 30 years ago. Total borrowing in relation to disposable, personal after-tax income leaped from 60 percent in the early 1980s to approximately 136 percent in the first quarter of 2008 before it began to recede. It is now about 117 percent of income, compared to the pre-bubble norm of 70 percent. To return to that level, debt would have to be reduced by another $6 trillion. Similarly, the debt-to-asset ratio in relation to household assets is currently 20 percent, but the pre-bubble norm was 12.5 percent.
In other words, the deleveraging process still has a long way to go. As more U.S. households seek to reduce their debts, the slowdown in consumer spending is likely to go on for a long time. Families and individuals typically tighten their belts and bolster their savings accounts in bad times or, alternatively, pay down their borrowings to ultimately rebuild their savings and net worth. The savings rate, which had averaged 8.6 percent during the 1980s and 5.5 percent in the 1990s, dropped to an alarming 2.8 percent in the 2000s. No longer are households engaging in mortgage equity cash-outs -- to the tune of over $80 billion per quarter -- as they did in 2006. Cash-out refinancing today has dropped by 90 percent, contracting the available funds that helped power the spending binge. In an era of job insecurity, Americans no longer take liquidity for granted. They want to know that if they hit a rough patch, they will be financially capable of getting through it.
The attitude toward debt has shifted dramatically in middle-class America. This will continue as more families realize that their retirement nest eggs are going to be a whole lot smaller than they expected. Credit cards provide a marker. According to surveys by Javelin Strategy & Research, only 45 percent of households used credit cards in 2010, compared to 56 percent in 2009 and 87 percent in 2007.
Similarly, the University of Michigan Consumer Sentiment Index, which had averaged 88.1 over the preceding 20 years, sagged to the mid-70s in December and January, well below levels that contributed to the exuberant economic expansion of the past. Virtually every index of consumer sentiment supports this general sense of consumer restraint. In a poll last year by the Pew Research Center, 71 percent said they were buying less expensive brands, 57 percent said they had trimmed or eliminated vacations, 11 percent postponed marriage or children, and 9 percent moved in with their families to save money. Others reported reducing spending on alcoholic beverages, clothing, and food away from home. There are roughly 25 million unemployed or partially unemployed people focusing on basic necessities. They make up part of the 42 million Americans on food stamps.
American households are seeking to become net savers, not net borrowers.
This is hardly surprising when expectations of household income have dropped and real median household incomes are down over 4 percent from the prior decade. Net worth has declined by about $100,000 for the average household compared to just three years ago, according to Rosenberg, and total household net worth is $12 trillion lower today than at the pre-recession peak -- an unprecedented decline of 18.5 percent over three years.
The bulk of this loss comes from diminished home equity, long the largest asset on the balance sheet of the average American family. With more than 6 million homes in inventory or foreclosure, prices have been declining again for the last six months, according to the S&P/Case-Shiller Index, and we may have a double-dip.
In short, the triple whammy of weak consumer sales, a weak housing market, and a deeply anemic job market is still very much with us. There are no quick fixes to the post-bubble credit collapse. The process of deleveraging is far from over. Current debt loads are not sustainable either by incomes or asset values, which are falling.
This is why our economic pulse is so weak.
Real GDP growth is less than half of what one would ordinarily expect to see coming out of such a deep downturn. We have had the weakest recovery ever in terms of the growth rate in real final sales. There has been virtually no recovery with respect to housing, personal income, or employment. The February jobs report reaped a slew of cheerful headlines, but much of the bounce came in construction, as those kept idle by January's snowfalls went back to work. In job gains, we've averaged 135,000 over the last three months; we need 150,000 just to keep pace with the growth in population. And the government unemployment numbers do not take into account the 2 million-plus discouraged or otherwise "marginally attached" workers, those who have dropped out of the labor force over the past year and a half and are still unemployed, or have not looked for work in the previous month. Had they been counted, the jobless rate would have been 11.5 percent in February.
Government programs may have provided an early, if minor, lift to the economy, but clearly they have not sustained it. What next?
One possible engine of recovery may be the improving profitability of corporate America, if the cash finds its way into increased capital spending and employment. That has yet to happen. Otherwise, the anemic recovery may yet require the jolt of a substantial new stimulus. For any such defibrillation shock to be effective -- or politically feasible -- it cannot spook the bond market, and that means the patient must be assured of longer-term reductions in the major expenditure programs of the federal government. Until we have a credible and convincing plan, it seems we'll have an economy that is neither certifiably dead nor robustly alive.
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