High borrowing and Spending cannot go hand in hand
13 JANUARY 2012
Johannesburg, South Africa
Yesterday's trading revealed nothing of importance. Small moves in stocks and gold. And oil dipped below $100.
But the news has been generally "good" ever since the European Central Bank made it clear that it will print money rather than see major banks or minor nations get what is coming to them. Like its US counterpart, the ECB will not permit a major bank or sovereign debtor to go bust.
"ECB sees signs of let-up in debt crisis," is today's headline in the Financial Times.
Let's see...the news report goes on to tell us that Spain and Italy were able to sell 22 billion euros of debt yesterday, proving that they can still finance their deficits...and that, therefore, we have nothing to worry about.
To whom did they sell their bonds? We don't know, but we presume the buyers were banks who were investing money they got on favorable terms from the ECB. So, you see, dear reader, that their willingness to buy the debt does not necessarily mean that either buyer or lender is solvent. Probably, neither is...
But with fears of a debt debacle in Europe off the front page headlines...the financial world has seemed rather benign, especially in America.
US stocks have rallied since October. The latest unemployment report from the feds was surprisingly upbeat. The dollar is strong. And US consumers are now re-leveraging, going deeper into debt in order to buy things.
Does this mean the Great Correction is over and done with?
Europe is either already in recession...or entering recession. Leading indicators in the Old World are plunging sharply...
Manufacturing in the US is softening... And European sales affect 20% of US corporate revenue... A strong dollar actually makes it harder for US companies to sell their products overseas, and it reduces the contribution made by foreign subsidiaries to US earnings reports.
Oil, meanwhile, has remained near $100 despite a sell-off in commodities and 'risk -on" assets. This leaves both business and consumers with little free cash to spend...and squeezed profit margins. Already, corporate profit margins are beginning to come down...as they should.
The Fed came out with its "Beige Book" this week. Our reading of the report - which includes updates from 10 districts around the country - is that conditions haven't gotten any worse...but that they haven't gotten any better either.
Most important, the two key ingredients in household wealth - wages and housing values - remain in a slump. None of the 10 districts reported much improvement in either area.
So, even if consumers did go on a bit of a shopping spree over the holidays, it is unlikely to continue. Because there is nothing behind it.
Remember, this time it IS different. This time there is nowhere to go but down. (More on that...below)...
Households could increase their debt levels in the '80s, '90s and '00s only because 1) they began at a fairly modest level, and 2) housing prices were going up. While household debt has come back down to levels of the early '00s...they have a long way to go before they are back to the long-term averages of the '60s, '70s and '80s.
As for employment, the latest numbers were better than they had been but hardly a sign of a real recovery. From the "WorkBlog" at the Washington Post:
On Friday, we got the December jobs number: +200,000. That's good, but not good enough. I posted a graph from the Hamilton Project showing that, at that rate, the labor market wouldn't recover till 2024. But perhaps that's too pessimistic. The Economic Policy Institute took a look at the same numbers and concluded that a growth rate of 200,000 jobs per month would lead to a full recovery in seven years or so. That's nothing to celebrate, but it's better than the Hamilton Project's estimate of 12 years. It's also a bit odd: Isn't this a simple matter of taking job losses and dividing by monthly job gains? Well, no. The date of our eventual recovery depends on some crucial unknowables about the future of the American labor force.
The blogger doesn't mention it, but even while the unemployment rate might go back to 'normal' in 7 to 12 years, the latest figures show household income still going down. That's not going to do much for household budgets or purchasing power. Or their borrowing power, for that matter.
Who's going to lend to households when both their ability to repay (their wages) and their collateral (their houses) are going down?
And what are aging baby boomers going to retire on, if they continue to borrow against declining collateral?
Our verdict: The higher borrowing and spending at the household level in December was a fluke, we believe, not a sustainable trend. The Great Correction continues...
---------------------------------------- Did you miss the Webinar? ----------------------------------------
Equitymaster's Webinar on the Future Prospects for the Indian Economy with Mr Ajit Dayal was broadcasted on 30th of December, 2011.
The webinar answered questions that could be troubling any Indian Investor today. Where is the Indian Economy headed in 2012? Is Gold still a good investment? Could the Stock Market touch the 21000 figure in 2012?
If you missed watching the webinar, here is your chance to access the same.
Click Here to watch: Indian Economy - From Darling to Damned (Rebroadcast)
And let's understand what lies ahead for India and how could this impact your investments.
*** "Americans think we are stupid," said a European diplomat at a dinner party in Washington. "But we're not stupid. We're just working out the problems involved in forming what you might call 'a more perfect union.'"
"Well, you can unify all you want...it won't make your debts go away," we replied. We always try to be a cheery presence at dinner parties...especially in Washington.
"No...but it will make us easier for us to manage them, just as you do here. And by the way, the US has about the same amount of debt as Europe. The latest figures show the average of all OECD countries is about 100% of government debt to GDP. The US is right in the center...right at the average."
"Oh, don't think I'm holding the US up as a superior example. Not at all. To the contrary, I'm just pointing out that if Europe follows the US model, it will go broke just like the US."
"Actually, there is some very intelligent and sophisticated thinking going on in Europe. I think you'd approve of it. We don't talk about it publicly, of course. Most people wouldn't understand. But we know that something very important has changed...and we are not at all sure how to respond to it.
"No country has ever been able to work its way out of such high levels of debt without exceptionally strong rates of growth...and an exceptionally good set of circumstances that make it possible - such as very agreeable creditors who essentially forgive debt, as the US did after WWI and WWII.
"And I don't see either of those things happening. The creditors can't forgive the debt...because they owe money too. They'd be broke too. And growth levels seem to have come down to negligible levels. If this continues, all our planning and all our efforts to 'build a more perfect union' will probably be for nothing."
"I'm glad to see you thinking along those lines. But you're aware that this is not a problem that just appeared in the credit crisis of '08?"
"Yes...we know it has been a long time coming. Ever since the end of the '30 glorious years' following WWII, real growth has been hard to get."
"Exactly. In the US, the average man of working age earns about 20% less, in real terms, than he did in 1972. If he only went to high school and not college, he earns nearly 50% less."
"In Europe, outside of Germany, the figures are similar...though not as bad, I believe."
"Yes, it was possible for the US to reduce its WWII debt because it ran very high rates of real growth up until the '70s. Same thing in Europe. Since then, most of the improvement in living standards has been smoke and mirrors. In America, women went to work. More people working more hours. They were able to increase household income...while the quality of life at home generally went to Hell. Then, when they couldn't work any more hours, they began borrowing money. Then, their balance sheets went to Hell. That is the reason, and the only reason, for the boom of the Clinton...and later, Bush...years. It was a phony, unsustainable boom...with phony, unsustainable growth."
"In Europe, it was a little different. People didn't want to work more. They wanted to work less. So they emphasized high wages....but fewer people had jobs. We learned to live with high unemployment. And governments borrowed to boost living standards for everyone - including those who didn't work."
"But those days are over. Nobody - household or government - can continue to borrow to raise living standards. And without more real demand...and real spending...and real wealth...it's not possible to work your way out of so much debt."
"Yes, this time capitalism really does seem to have failed us," our diplomat friend concluded.
"Well, it looks that way. You have to ask. How is it possible that the most dynamic, best capitalized, most high-tech economy in world history could not add a single dollar to the real wealth of the average working man over a 40 year period?"
More to come...
© Equitymaster Agora Research Private Limited