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Why consumers aren't consuming

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  1. Consumer confidence is down to levels not seen since the 1973-75 and 1980-82 recessions.
  2. Real wage growth and real income growth have been stagnant in the last few years as income and wealth inequality have been rising. And now with GDP and real incomes falling, real consumption will fall sharply.
  3. The Fed is reaching zero-bound on interest rates as the economy gets close to deflation, given the slack in goods, labor and commodity markets. Deflation means consumers will postpone consumption as future prices are lower than current prices, as real rates are positive and rising, and as debt deflation increases the real value of households’ nominal debts.
  4. Employment has been falling for 10 months in a row and the rate of job losses is now accelerating. In the last recession in 2001, which was short and shallow (eight months from March to November 2001, with a cumulative fall in GDP of only 0.4 percent), job losses continued until August 2003 — with a job-loss recovery and a total cumulative loss of jobs of over 5 million from the peak. In this cycle, job losses have, so far, been “only” slightly over a million, while labor market conditions are severely worsening based on all forward-looking indicators, such as initial and continuing claims for unemployment benefits. Massive job losses and concerns about job losses will further dampen current and expected income, and further contract consumption.
  5. Tax rebates of over $100 billion failed to stimulate real consumption earlier in 2008. Only 25 percent of the rebate was spent as U.S. consumers are worried about jobs and needed to use funds to pay off their credit cards and mortgages. The tax rebate was supposed to boost consumption all the way through September 2008. In reality, real retail sales and real personal spending rose only in April and May, while starting in June and all the way through October and now the holiday season, real retail spending and real personal spending have been down month after month.
  6. The 1990-91 and 2001 recessions were not global; this time around, the IMF is forecasting a global recession for 2009.
  7. The recent rise in inflation — that is only now slowing down — reduced real incomes even further for lower-income households who spend more than the average households on gas, transportation, energy and food. The recent sharp fall in gasoline and energy prices will increase real incomes by a modest amount (about $150 billion), but the losses of real disposable income and thus falling consumption from other sources (wealth, income, debt servicing ratios) are much larger and more significant.
  8. The trade-weighted fall in the value of the U.S. dollar since 2002 has worsened the United States’ terms of trade and reduced further real disposable income and the purchasing power of U.S. consumers over foreign goods.
  9. Monetary easing will not stimulate durable consumption and demand for residential housing, as demand for such capital goods becomes interest-rate insensitive when there is a glut of capital goods. In the previous recession, the Fed cut the Fed Funds rate from 6.5 percent to 1 percent and long rates fell by 200 bps. In spite of that, capital expenditure in the corporate sector fell by 4 percent of GDP between 2000 and 2004 as there was a glut of tech capital goods which took years to work out. Today, there is a glut of housing, consumer durables and automobiles; it will take years to work out this glut and monetary policy is becoming ineffective to resolve it.
  10. To bring back the household savings rate to the level of a decade ago (about 6 percent of GDP) consumption will have to fall — relative to current GDP levels — by almost a trillion dollars. If all of this adjustment were to occur in 12 months, GDP would contract directly by 7 percent and indirectly (including the further collapse of residential and corporate capital expenditure in a severe recession) by 10 percent, an exemplification of the Keynesian “paradox of thrift.” If such an adjustment were to occur over 24 months rather than 12 months, you would still have negative GDP growth of 5 percent for two years in a row with a cumulative fall in GDP from its peak of 10 percent. (Note that in the worst U.S. recession since WWII, such cumulative fall in GDP was only 3.7 percent in 1957-58). One can only hope that this adjustment of consumption and savings rates occurs slowly over time — four years, say, rather than two.

Source: Nouriel Roubini, Forbes


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