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LQD: The Deleveraging US Consumer

by Melanchthon Fri Aug 21st, 2009 at 03:16:37 AM EST

A lot has been said about the coupling or decoupling of the US and global economies. While the US has indeed been the locomotive of the global economic train until a few years ago, the current situation is, in my view, more like a "limited-slip coupling" (once a mechanic...) and I think the current crisis will probably contribute to further de-coupling. But whatever one thinks about it, it is clear that the future of the global economy and the balance of global economic and geopolitical power will be significantly impacted by the evolution of the US economy in the decade to come.  While I don't agree with those who think that US consumption is the only driver that will get us out of the current crisis, the fact that consumption represented more than 75% of the US GDP growth in the years 2000 to 2007 means its evolution will play a critical role in shaping the future of our economies. So, it's worth having a look at an interesting paper on Zero Hedge:

A Detailed Look At The Stratified U.S. Consumer

When analyzing the recovery prospects before the U.S. economy, no analysis is complete without a detailed look at the capacity of the U.S. consumer, that dynamo that has always managed to pull the economy out of whatever hole it managed to find itself over the past 80 years. However, permanent structural changes to the economy and the first credit-based recession in decades, could mean the proverbial "this time it may be different" is applicable.

promoted/bumped by whataboutbob


It is worth reading the whole article (it provides interesting graphs). However, I will skip the first part of it which will merely be a reminder for ET readers - the indebtedness and consumption binge of US households having been widely covered since the creation of this site - to focus on two issues: the deleveraging problem and the dire economic situation of the US middle-class regarding the said deleveraging:

The Deleveraging consumer

The sharp recent upswing in the chart below indicates that consumers on average are commencing a paradigm shift to frugality as the "wealth effect" evaporates: the increase in consumer wealth lead to an increase in consumption financed by rising asset values. [...] The double whammy of a collapse in both the equity market and housing values will ultimately result in an increase in savings rates to long-term averages in the 9-10% range. And, as pointed out above, the adverse economic impact of this transformation in the consumer psyche will likely be in the $2-3 trillion range.

Well, I think that, to the impact of the collapse of equity and housing values, we must add the rising unemployment and the decrease in wages as factors pushing to a strong and sustained increase in savings.

So how deep will this deleveraging process will go and  how long will it last?  According to Zero Hedge:

The biggest concern from a reversion to the mean perspective is that if the ongoing deleveraging trend were to follow its full course, household debt-to-income would have to decline by 27 bps to its long-term trendline, in effect extracting $2.8 trillion from the economy.

Here I beg to differ from their analysis: these 27 bps refer to what they call the "long-term trend line". If you look at the graph, that would mean returning to a "normal"(!) ratio of around 115% of disposable income in 2009 (and more in the future). However, this long-term trend line is strongly influenced by the debt growth that started in the mid-80s. Maybe it would make more sense to look at what was the long-term trend line before Reagan policies led to substitute debt for wage growth:

Going back to a debt to disposable income ratio situated between 60% and 65% means a decline of 73 to 78 bps from the 2007 peak level of 138%. I am not sure it has necessary to go back to 60%, but I think there should be, at least a reflection about what constitutes a sustainable debt to income ratio.

The dire situation of the US middle-class

But, facing debt and deleveraging, not all US citizens are equal:

A drill down of disposable net income (after tax) and net worth, demonstrates why any discussion of "generic" consumers should be much more properly phrased as an observation of the "Wealthy" and "Everyone else".

The disposable income difference between the richest 10% and even the next richest decile is staggering: a 3x order of magnitude. And a fact that Taleb fans would likely appreciate most, the pretax income difference between the median and mean for the top decile is shocking: $206,900 versus $397,700. This is skewed by a statistically low number of outliers earning an abnormally large amount of disposable income.
...
Probably the most dramatic observation appears when evaluating relative leverage of the various consumer classes.

It is apparent that the problem of consumer (de)leveraging is actually one of a Middle class burdened with excess debt. The debt-to-income ratio for the middle class is on average more than 200%, almost double that of the highest decile, "Upper Class."


The divergence among the classes is even more obvious when comparing aggregate net worths:

While 10% of the population collects 40% of disposable income, it represents 57% of net worth! This is an impressive conclusion: on a lowest common denominator, the Net Worth variance between the 10% of the population that make up the wealthy and the 50% that comprise the middle class is over 8x!
...
when looking at data historically, it is once again the top decile, or the "Upper" Class the benefitted consistently over the the past 15 years, to the detriment of both the low-income and the middle-classes, which represent 90% of the population.


...
Yet estimates demonstrate that even though on an absolute basis the wealthy are losing overall consumption power, the relative impact has hit the lower and middle classes the strongest yet again.


...
And to add insult to injury, the segment of housing that has been impacted most adversely in the current downturn, is lower and middle-priced housing: that traditionally occupied by the lower and middle classes.

I certainly do not share the opinion of the author, who, after having made a very articulate analysis of the situation, argues that, given that the richest 10% represent 40% of the US consumption, they should be cajoled into consuming again and not taxed more, and says nothing about what policies/measures should be adopted to tackle the situation in which tha middle-class is mired (Vae Victis!).

Given the size of the problem facing the vast majority of the American households and particularly the middle-class, only a massive redistribution from the uber-wealthy to the middle and lower income categories will provide a sustainable solution. This means: - ending the current system that allows the financial sector to grab the biggest part of the wealth created - a major overhaul of the wage system towards a better sharing of the created wealth - a bold reform introducing a strong redistributive tax policy. Will the Obama administration be able (let alone willing) to implement a bold enough reform to help the middle and lower income classes to get out of their economic situation? Unless they do so, the US will most probably be facing many years of very slow growth and high unemployment until these categories have gotten rid of their debt.

Display:
I seriously doubt the Obama administration will be able (let alone willing) to implement a bold enough tax policy to help the middle and lower income classes to get quickly out of their economic situation. That means the US are facing many years of very slow growth until these categories have gotten rid of their debt.

"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet
by Melanchthon on Wed Aug 19th, 2009 at 02:33:48 PM EST
Even more, income growth at a sufficiently rapid pace to get lower and middle income class Americans out of our economic situation based on the Old Energy Economy would risk another oil price shock, either via global oil demand or via a collapse of the US$.

This is the foundation of my argument for what I have been calling a "Brawny Recovery", a slower, income-led economy founded on restoring US public infrastructure investments to pre-Reagan norms while focusing the investment in building up capacities in the New Energy Economy to support complementary private investment in associated productive capacity.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Aug 21st, 2009 at 12:53:39 PM EST
[ Parent ]
This is the foundation of my argument for what I have been calling a "Brawny Recovery", a slower, income-led economy founded on restoring US public infrastructure investments to pre-Reagan norms while focusing the investment in building up capacities in the New Energy Economy to support complementary private investment in associated productive capacity.

That is the only path out I can see.  But before we can effectively pursue that path it seems to me that we must deal with the overgrown financial sector.  If they are allowed to finance a "brawny recovery" it would likely be through a "brawny bubble"!  And that we don't need.

The wife had MSNBC on last night while I was in another room doing sink repair.  Talking about Bernanke's reappointment or replacement.  The usual hystronics.  Then I passed by and commented that what was needed was to get rid of Geithner and shut down Citi and other big banks.  "That is what they are saying,"  she responded, so I stopped and listened.  Sure enough one of their controversy bears was saying that some big banks would have to be "resolved." Having that said on MSNBC seems like a milestone.


"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Aug 21st, 2009 at 01:21:19 PM EST
[ Parent ]
Yes, as you know, my argument for coping with the financial sector is bring the parts Main Street needs into receivership, with claim or credit to the original financial institution based on whether they had enough sound assets to bring the books of that part into a sound financial position, and then let the original financial institution go through ordinary bankruptcy.

OTOH, that plan is less likely to generate the contributions from the Finance industry that Obama's Hedge Fund wing of the Democratic party relies upon.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Aug 21st, 2009 at 05:51:02 PM EST
[ Parent ]
and that is precisely why Republicans, and even wealthy Democrats such as Warren Buffet in today's Wall Street Journal, are either wary of or outright opposed to incurring large national debts to stimulate current spending.  Massive debt has only one possible, long term policy solution: raising taxes on the wealthy, which is why stimulus spending is really a transfer of wealth from the rich to the less rich. It's not a question of whether such transfer might happen. It already IS happening.
by santiago on Wed Aug 19th, 2009 at 02:51:30 PM EST
to banks and bank-holding corporations to-date? Who owns most of the stock in these institutions? Who makes (and has made for decades) millions and billions in salaries, bonus, commissions, and stock transactions?

How much 'Stimulus' money has been spent to-date? How much of that actually went to a Small Business or to a wage-earner? If we knew the actual dollars paid/promised/created via TARP and related policies, we could run the numbers. Various estimates make the ratio between 6:1 up to 25:1.

I agree with you when you write: "... Republicans, and even wealthy Democrats such as Warren Buffet in today's Wall Street Journal, are either wary of or outright opposed to incurring large national debts to stimulate current spending.  Massive debt has only one possible, long term policy solution: raising taxes on the wealthy,...". I would end your comment about there.

Lacking that degree of concision, my response is "Sounds good to me, if a bit underwhelming so far."

paul spencer

by paul spencer (spencerinthegorge AT yahoo DOT com) on Wed Aug 19th, 2009 at 08:46:29 PM EST
[ Parent ]
The stimulus and the bank bailout are two different things, with two different sets of fiscal commitments. The stimulus commitment, which is both consumption spending and infrastructure investment, really is a transfer of wealth from the rich to the less rich whom might have lost their jobs if not for the government provided stimulus.

The bailout is largely a transfer from some of the wealthy to other wealthy people, and to the extent that some of that transfer is unjustified, it may not be unfair to compare it to a public form of Bernie Madoff.  

However, on net, the transfers of wealth due to policy interventions do appear to be transferring wealth from future high income people to present day low and middle income people, and that's why conservatives oppose it so, even though their own macroeconomic narrative -- monetarism -- agrees with liberals' Keynesian playbook regarding the need for expansionary fiscal and monetary policy in the present crisis.

by santiago on Thu Aug 20th, 2009 at 10:39:31 AM EST
[ Parent ]
To Hell with theory.  They don't like giving money to anyone, especially the poor.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Aug 20th, 2009 at 01:47:02 PM EST
[ Parent ]
naked capitalism: Consumers Tightening Belts, Raising Worries About Recovery
From the Wall Street Journal:
Major retailers reported that American consumers are continuing to hunker down, casting a cloud over the durability of the U.S. recovery and underscoring the importance of overseas demand in restoring the world economy to health.
...
American consumers appear so shaken by the worst recession since the Great Depression -- and so pinched by unemployment, stagnant wages and stingier lenders -- that they are reining in spending on all but basics. Economists also see an upturn in U.S. household saving as the beginning of a prolonged period of thrift.....
...
Earlier this week, the Federal Reserve said a July survey of banks found continued tightening of lending standards as well as a diminished appetite for borrowing among consumers. About a third of banks said they tightened lending standards on credit cards and other consumer loans since April. No banks reported relaxing them.


"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet
by Melanchthon on Wed Aug 19th, 2009 at 05:42:21 PM EST
A week ago I made a comment derived from reading the Zero Hedge article you cite in which I questioned the vigor and sustainability of the reported recovery in France and Germany.  Given the role that the US consumer has played for the last decade+ in maintaining growth in the global economy I had doubts as to the US consumer continuing to play that role and concerns about the impact that would have on the global economy.  I was not trying to say that Europe was doomed or to gloat that you were in the same boat as the USA, although that may have been how my comment was perceived.

I think it has been a disaster for the US economy and society to allow the US to become the consumer of last resort and to encourage US citizens to draw equity out of their homes to maintain consumption levels.  That only provided a temporary benefit to Wall Street, which is now gone, but the debt remains.  And far too much of our manufacturing remains in China and elsewhere.  Those who maintained that we could not survive as a nation of service providers and hamburger flippers are being proved right.

China has committed to increasing domestic spending, and, as they have vast social infrastructure needs this will help, as will similar spending in India.  But the total size of the domestic, as opposed to the export sides of those economies is small compared to the need.

These factors were all well described in a prescient article by Dr.  André Lara Resende, a well-known Brazilian economist, whose paper, After the Crisis: Macro Imbalance, Credibility and Reserve-Currency  William Buiter made the subject of his June 6 Mavercon blog.  It remains worth a read.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Aug 19th, 2009 at 09:59:02 PM EST
[ Parent ]
to point out that the US was NOT the consumer of last resort - or only for some of the Asian mercantilist economies.

And my response on the sustainability of French and German recovery lies on recent statistics showing that personal incomes are still growing in France and Germany, thus sustaining consumption fairly naturally (withotu recourse to more debt).

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Thu Aug 20th, 2009 at 03:53:20 PM EST
[ Parent ]
personal incomes are still growing in France and Germany, thus sustaining consumption fairly naturally (withotu recourse to more debt).
And I continue to be gratified by this fact and continue to hope that it will continue.  It is good that at least two western countries can keep their heads above water.  One of my concerns about the mismanagement of the US economy is that it might drag everyone down with it.


"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Aug 20th, 2009 at 10:47:56 PM EST
[ Parent ]
In my view, the only sustainable solution is to have a massive redistribution from the uber-wealthy to the middle and lower income categories through a strong tax reform and fiscal policy. Is there any chance that will happen?

The first indicator will be if we can at least halt the extraction of wealth from 95% of the population by the financial sector, which has been the great engine of wealth extraction by and transfer to the top 1%.  At present the policy remains "All Money to the Banks!"  Even retired people with modest savings cannot safely earn a meaningful return from them and have to draw down their savings instead.  Meanwhile those still working who have any debt are getting massively ripped off by the banks with the encouragement of the Fed.  The Obama Administration seems to have no real concern for any but the very large banks.  Not encouraging.  My advice to Europe is: "Don't count on US!"

Worse, we are to financial predation as Somalia is to piracy.  Better that the rest of the world should insist that we clean up our own pirates.  That would make growth easier.  Best would be to resolutely move to a sustainable economy not based on growth of non-renewable resource consumption.  

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Aug 19th, 2009 at 10:16:03 PM EST
As a newbie, I am anxious to know.

Is it another obscure Finnish acronym?

by senilebiker on Thu Aug 20th, 2009 at 03:55:20 AM EST
"Lazy Quote Diary."

Usually used for very short diary entries where someone wants to quote a snippet of a blog or article, this one probably didn't need the acronym as it is fairly long.

you are the media you consume.

by MillMan (millguy at gmail) on Thu Aug 20th, 2009 at 04:15:52 AM EST
[ Parent ]
With a few edits here.

"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet
by Melanchthon on Thu Aug 20th, 2009 at 06:21:16 AM EST
... in simplest terms, it is a level, not an upward trend.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Thu Aug 20th, 2009 at 04:20:55 PM EST
The Two-Track Economy - Simon Johnson - The Baseline Scenario
But at this stage in our economic boom-bust cycle, is it still helpful to think in terms of one aggregate measure of output?  Or are we seeing the emergence of a two-track economy: one bouncing back in a relatively healthy fashion, and the other really struggling?
...
The United States has, over the past two decades, started to take on characteristics more traditionally associated with Latin America: extreme income inequality, rising poverty levels, and worsening health conditions for many.  The elite live well and seem not to mind repeated cycles of economic-financial crisis.  In fact, if you want to be cynical, you might start to think that the most powerful of the well-to-do actually don't lose much from a banking sector run amok - providing the government can afford to provide repeated bailouts (paid for presumably through various impositions on people outside the uppermost elite strata).

Ultimately, of course, you get lower growth.  But by the time that is clear in the numbers, it may be too late to do much about it.



"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet
by Melanchthon on Fri Aug 21st, 2009 at 06:02:39 AM EST
After a 30-Year Run, Rise of the Super-Rich Hits a Wall - NYTimes.com
But economists say -- and data is beginning to show -- that a significant change may in fact be under way. The rich, as a group, are no longer getting richer. Over the last two years, they have become poorer. And many may not return to their old levels of wealth and income anytime soon.
...
Just how much poorer the rich will become remains unclear. It will be determined by, among other things, whether the stock market continues its recent rally and what new laws Congress passes in the wake of the financial crisis. At the very least, though, the rich seem unlikely to return to the trajectory they were on.
...
"We had a period of roughly 50 years, from 1929 to 1979, when the income distribution tended to flatten," said Neal Soss, the chief economist at Credit Suisse. "Since the early '80s, incomes have tended to get less equal. And I think we've entered a phase now where society will move to a more equal distribution."

Few economists expect the country to return to the relatively flat income distribution of the 1950s and 1960s. Indeed, they say that inequality is likely to remain significantly greater than it was for most of the 20th century. The Obama administration has not proposed completely rewriting the rules for Wall Street or raising the top income-tax rate to anywhere near 70 percent, its level as recently as 1980. Market forces that have increased inequality, like globalization, are also not going away.

Ahem! Political submission to (or promotion of) unregulated, untamed market forces has increased inequality...

I think incredibly high incomes can have a pernicious effect on the polity and the economy," said Lawrence Katz, a Harvard economist. Much of the growth of high-end incomes stemmed from market forces, like technological innovation, Mr. Katz said. But a significant amount also stemmed from the wealthy's newfound ability to win favorable government contracts, low tax rates and weak financial regulation, he added.
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Beyond the stock market, government policy may have the biggest effect on top incomes. Mr. Katz, the Harvard economist, argues that without policy changes, top incomes may indeed approach their old highs in the coming years. Historically, government policy, like the New Deal, has hadmore lasting effects on the rich than financial busts, he said.

One looming policy issue today is what steps Congress and the administration will take to re-regulate financial markets. A second issue is taxes.



"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet
by Melanchthon on Fri Aug 21st, 2009 at 07:27:16 AM EST
that the super rich's wealth is going down in absolute terms is certainly true. That it is going down in relative terms does not seem likely, given that they are the biggest beneficiaries of the multi-trillion bailout.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Aug 21st, 2009 at 05:21:38 PM EST
[ Parent ]
Yes, that's the comment I made on a bonddad diary on DKos. If there is no radical change in the wages and tax policies (and a strong reform of the financial system), the likely outcome will be a higher level of inequality...

"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet
by Melanchthon on Fri Aug 21st, 2009 at 05:42:18 PM EST
[ Parent ]
Galbraith:

There seems little question that in 1929, modifying a famous cliche, the economy was fundamentally unsound. This is a circumstance of first-rate importance. Many things were wrong, but five weaknesses seem to have had an especially intimate bearing on the ensuing disaster. They are:

(1) The bad distribution of income. [...]

(2) The bad corporate structure. [...]

(3) The bad banking structure [...]

(4) The dubious state of the foreign balance. [...]

(5) The poor state of economic intelligence. [...]

  1. Highly unequal income distribution. Check.

  2. Weakened corporate system, largely submissive to financial actors. Check.

  3. Cascading margin calls on banks. Check.

  4. Excessive current accounts surplus. Nope.

  5. The conventional economic wisdom out to lunch. Check.

Well, four out of five ain't too bad.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Aug 22nd, 2009 at 11:54:56 AM EST
But the US would be better off were it five of five.  Having a current account surplus at this time would be a major benefit.  Instead we have what is probably an unprecedented deficit.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Aug 24th, 2009 at 04:31:32 PM EST
[ Parent ]
I would say that

The dubious state of the foreign balance.

fits even better with an unprecedented deficit then with excessive current accounts surplus.

Though I am not sure if it would fit the rest of point 4, and Amazon requires an account for letting me search through the book online.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Wed Aug 26th, 2009 at 05:55:49 AM EST
[ Parent ]
Excessive surpluses carry a different bag of challenges. Namely the contractionary impact they have on the rest of the world, and the fact that during a financial meltdown of 1929 proportions, money stops flowing easily across borders to finance trade deficits.

So overseas countries with current account deficits w.r.t. the US had to scale back on those deficits by increasing exports and/or foregoing imports. This is, of course, a further contractionary effect for the US.

Moreover, the depressing effect of US-made imports on their economies will further provoke them to improve their trade balance during a downturn in domestic employment rates. The contractionary effect of imports will not be an issue in the absence of mass unemployment, so there is likely to be some slack available. This has, as noted, further contractionary effect on the US.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Aug 28th, 2009 at 02:50:43 PM EST
[ Parent ]


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