Why do American consumers spend less?

Well. The financial system in the US is still not completely shored up. AIG just reported a loss of 25 billion dollars for the third quarter and will be receiving a 150 billion aid package. Fannie Mae lost 29 billion dollars. Circuit City is going down. Airlines are in trouble. GM and the whole American car industry is in deep trouble.

As for the overseas markets, most indicators are down there as well. Every time the numbers are revised, they get worse. Right now, according to Wall Street Journal, they indicate a deep recession in Europe as well. IMF (see figure) now assumes that 2009 will be worse than 2008 for the world as a whole.  For 2009   IMF predicts a decline in GDP in the advanced economies of 0.3 percent. If this happens, it will be the first time during the periode following the Second World War.  For the US IMF predicts a decline of  0.8 percent, and for the Euro-area 0.7 percent for 2009. So there will be little pull from overseas markets for American businesses.

Now, add to this that the banking system isn’t working, loans are hard to get, unemployment is on the rise and millions of jobs are threatened.  Consumer confidence is at the lowest ever.

Also, factor in a negative wealth effect. The positive wealth effects, the effect of people getting richer on paper when housing prices were rising, were key to the growth the last 5-7 years. Now this operates exactly in the opposite direction, and serves to limit peoples spending up and above the effects of other factors.

So, what does it mean?

So how likely is it that consumers will start spending in the near future? Not very. Let’s assume for a moment that consumer spending will continue as today for a while.

Consumer spending is down 30 percent on cars, and 3 percent on the average across all sectors. Consumer spending appears likely to fall next year for the first time since 1980. Perhaps by the largest amount since 1942.

If it stays the way it has been for the last three months for a full year, that means demand for goods and services from consumers in America will be down about 1200 billions. And, spending is still dropping. As well, demand from businesses is dropping. And, as I wrote above, demand from abroad is falling as well. And right now, American businesses have just barely started to adjust to these new numbers and levels. And this adjustment will mean more lay offs and more negative earnings reports. That is simply how it works. And it is hard to see any “quick fixes” that can act as a miracle cure and lift us out of this situation in the short term. Rather, the adjustments will have to work their way through the system.

As far as American consumers are concerned, I notice people using words like “lacking trust” or “fear” as reasons for the decline in consumption. These words suggest that consumers are driven by psychological factors, emotions, beliefs and sentiments. Such words, I think, are the wrong ones in this case. Right now, I think American consumers act very rational – markets are turbulent, times are getting harder, uncertainty is high, so the rational response is to buckle down, sit still and wait for the fog to clear up.

So, for the moment, and for a while, it is just going down, I think. We are nowhere near the bottom. I don’t think we will see new growth for at least 18 months.

That’s what I think.

See also:

• Yahoo Finance: Home values drop for 7th straight quarter
• New York Times: Best Buy Lowers Its Outlook for 2009
• Washington Post: Why GM Stalled
• Washington Post: Obama Asks Bush to Back Rescue of Automakers
• New York Times: A Town Drowns in Debt as Home Values Plunge
• Wall Street Journal: Indicators Across Europe Point to Deeper Recession
• New York Times: Jobless Rate at 14-Year High After Big October Losses
• Times:First full-year slump since 1940s, says IMF

©2010 from the hip. All Rights Reserved.

housing woes will continue as the economy wavers from the sharp drop in home building, credit and stock market turmoil, and a slowdown in consumer spending.

The study also adresses the negative wealth effects of the current situation in the housing market:

“Further price declines will not only increase the probability that mortgage defaults end in foreclosure, but also put a tighter squeeze on consumer spending,” the report stated.

As well, the report states that if the economy plunges into a severe recession, housing demand could fall even further. Many factors seem to still point in this direction. There are a number of negative indicators:

American Express experiences late card payments increasing

House prices dropping

Consumer confidence still dropping

The oil price is still rising

And so on and so forth. At the same time, inflation is on the rise, and while the Fed now is expressing strong concerns about this, they have still not really adressed it. My sense is that they will soon have to.

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In an article in the New York Times, Andrew Stettner called for an increased focus on the job market in the US:

“People have been focused on the housing crisis, and rightly so,” said Andrew Stettner, a policy analyst at the National Employment Law Project, “but now the deterioration in the job market should be demanding much more attention from policy makers.”

The job cuts so far in the US seem to be fairly consistent with the early stages of a period with a reversal of the wealth effect. According to Washington Post the distribution of job cuts was:

The numbers are far worse than economists were forecasting, and they solidify the case that a serious economic downturn is underway.
….

The report shows clearly how the problems in the housing and financial markets are rippling through different sectors, showing the deep interconnections between seemingly separate parts of the economy.

The number of construction jobs, which has been falling steadily for 18 months, continued its rout. That sector shed 51,000 positions, as fewer residences are being built.

Fewer houses mean less construction and building materials; the number of manufacturing jobs fell by 48,000, with some of the steepest losses among makers of lumber, drywall and other materials. Automakers also shed jobs. With their homes less valuable, Americans seem to be holding off on big-ticket purchases.

Consumers pulling back means stores need fewer workers; the number of retail jobs fell by 12,400. The steepest losses were in sellers of building materials and appliances, both of which are highly tied to the housing business.

The branches of the economy, of course, are not seemingly separate. They are visibly interconnected. Job cuts are most severe in construction and associated industries. Then there are wealth effect consequences in the auto industry and consumer retailing. Its logical and as expected.

As to the depth and duration of this crisis, this is what Ian Shepherdson had to say in NYT today:

Many forecasters argue that the economy will rebound by the fourth quarter, a view rejected by Ian Shepherdson, chief domestic economist for High Frequency Economics.

“We are in for a much longer recession than Wall Street thinks,” he said. “This particular downturn is driven by a rare contraction in consumer spending, and that is starting to hurt a broader range of people than those hurt by the mortgage crisis.”

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The fall in the housing market, which is likely to last for quite a while – I think well into 2009 – has another disturbing effect. It reduces the value of property in America. Thus, the wealth effect – everybody getting “richer” because the value of their houses and apartments have increased, and spending some of that newfound wealth on consumption – is reversed. Now there is a negative wealth effect.

A negative wealth effect means that this time increased spending will not be fuelling the economy and lifting it out of recession.

The effects of the reversal of the wealth effect are now slowly becoming visible in the US. Automakers are adjusting their sales expectations down:

Dismal Year Is Forecast for Car Sales

writes New York Times. And it doesn’t stop there:

Slump Moves From Wall St. to Main St.

In Seattle, sales at a long-established hardware store, Pacific Supply, are suddenly dipping. In Oklahoma City, couples planning their weddings are demonstrating uncustomary thrift, forgoing Dungeness crab and special linens. And in many cities, the registers at department stores like Nordstrom on the higher end and J. C. Penney in the middle are ringing less often.

… Many economists forecast that overall consumer spending will slip 1 percent for the first three months of the year.

“That’s a wow,” said Robert Barbera, chief economist for the trading and research firm ITG. “Outright declines for real consumer purchases are unusual.”

What is shaping up as the second recession of the 2000s is the product of declines in home values, which play a far bigger role in most Americans’ personal finances than the stock market. Households have borrowed against the increased value of their property to buy cars, send their children to college and add home theater systems.

What all the stories of declining demand point back to, is of course the wealth effect. And in months to come, it will increasingly be reinforced by imported inflation, making the crunch on the dollar increasingly felt by the consumers as well.

Indeed – all the charts for the US look bad for the moment: Jobless claims up, consumer sentiment down, housing starts down, retail sales down, industrial production down, dollar down. Meanwhile, the stock market will continue to be turbulent.

To me, it seems a rough ride is ahead!

More to come.

©2010 from the hip. All Rights Reserved.