R=MC2 Economic Recovery and the Misunderstood U.S. Consumer Conundrum

R=MC2

Economic Recovery and the Misunderstood U.S.  Consumer Conundrum

By Bill Dahl

All Rights Reserved 2009

The US Consumer

No, the formula above is not a misprint. Einstein’s famous E = mc2 was attempting to illustrate that matter and energy are simply different forms of the same thing – energy can be converted to matter and matter into energy. In the current economic dialog in the U.S., economists and political pundits would like us to buy into another formula they seem to be purveying. It looks like this: R=MC2. In other words, economic recovery and the U.S. consumer have a similar, symbiotic relationship. U.S. consumers are tantamount to a recovery and recovery can restore the U.S. consumer. They both matter. Sounds reasonable, until you examine the assumptions, illusions, realities, and uncertainties that underlie the merits of this thesis. What if R=MC2 is a formula that requires us to explore the Recovery and the Misunderstood Consumer Conundrum? Well, that’s exactly what this article intends to do.

According to the September 4, 2009 issue of Banc Investment Daily:  “Without credit expanding in the marketplace, the US economy is almost 100% reliant on a consumer led recovery that will not occur until firms start hiring again.” (emphasis is mine). Today, you hear this phrase everywhere; the consumer, the American consumer, consumer spending, waiting for a consumer stimulated recovery Did you realize that consumer spending produces about two-thirds of all the economic activity in the U.S.? Who are these people? Why aren’t they spending? What’s changed? According to one source, they’re out of the economic game for the moment “The big driver of the economy is still on the sidelines. The household sector is worried about the job market and until that shows some significant improvement, households are going to be pretty restrained,”(1) — On the sidelines? Restrained? What’s going on? What’s really going on?

First of all, what are the characteristics you must possess to be considered a “U.S. consumer? Here’s a few attributes to consider:

  1. Your dog cannot buy dog food at Wal-Mart. No matter how hungry that beast might become, you, the human companion, must transport yourself to the store and do the deed.
  2. Capacity – Currency – Yes, money. You simply must have some. Of course, that might be in one of several forms like cash, a credit card or credit line.
  3. Need – There must be a fundamental need that requires satisfaction that moves you to act upon satisfying the need by exchanging your currency for a product or service that will fulfill the need.
  4. Willingness – You must be willing to part with some of the currency you have (you’re the buyer, as they say) to acquire something from a seller.
  5. Yes, I know – you probably should reside the majority of the year in the U.S.

The above sounds pretty simple. It is, unless you’re contemplating whether or not the historical definition of the U.S. consumer has somehow changed tangibly as a product of the current recession we are experiencing. Economics is a social science, just like psychology or sociology. It has a penchant to look at the past for explanatory power that can be applied to both the present and the future. Typically, this economic information is embedded with statistics and the inter-relationships among the statistics. Human beings elaborate on the interrelationship insights for us. At times, this explanatory power is misguided and inaccurate. In his award winning book, When Genius Failed – The Rise and fall of Long Term Capital Management, Roger Lowenstein characterizes one of the central weaknesses of the firm, that is pertinent to this point: “The partners assumed that, all else being equal, the future would look like the past.” (2)

At this time, in the midst of this particular economic conundrum, I hear a chorus of voices in the economic and political sectors singing the same ol’ tune – the same song my mom taught me about a lost puppy:

“Oh Where, Oh where has the American consumer gone?

Oh where, Oh where can he or she be?

With his ears cut short and her tail cut long,

Oh where, Oh where can he or she be?”

It’s like economists and pundits are looking for a pack of lost dogs. What if the appearance of the lost dogs you were looking for had changed? How would you know what they now looked like? How would you be certain if you had found the right dog? What if some of the dogs had been hurt and were hunkered down somewhere, dizzy, scared, hungry and nauseous? What if some of the dogs had died, unbeknownst to you? How many are you looking for? How would you know? Are you certain?

Listen to Nassim Nicholas Taleb, from his most recent book, The Black Swan – The Impact of the Highly Improbable:

“Categorizing is necessary for human, but it become pathological when the category is see as definitive, preventing people from considering the fuzziness of boundaries, let alone revising their categories.”(3) The long held notion of the U.S. consumer has now escaped the confines of the definitive box where we have held them for so long.

It is the thesis of this author that:

  1. The historical characterization of the term American consumer has tangibly and substantively changed. It has eroded. Both the capacity and behavior of the U.S. consumer that has been broadly relied upon as descriptive for previous historical epochs, has morphed – in a negative way. Thus, wishful thinking that yearns aloud for and/or prophecies concerning the imminent resurrection of the old American consumer, is both out of date and fraught with the propensity for disappointment, miscalculation and deception.

2.Quoting Psychologist Franz Epting,  using an excerpt from Rom and Ori Barfman’s most recent book entitled, SWAY – The Irresistible Pull of Irrational Behavior, the following quote poignantly reinforces my position stated above: “We use diagnostic labels to organize and simplify. But any classification that you come up with has got to work by ignoring a lot of other things — with the hope that the things you are ignoring don’t make a difference. And that’s where the rub is. Once you get a label in mind, you don’t notice things that don’t fit within categories that do make a difference.” (4)

My position is that the label, U.S. Consumer, as historically referred to by present-day economists and politicians, simply does not accurately reflect the actual contents of what’s in the jar it is affixed to. The contents have changed. The label and people’s use of it has remained unchanged. There are things that we are currently ignoring that do make a difference. Do we need a new label or should we examine the current contents of what comprises the U.S. consumer inside the jar?

3. The capacity of the present-day U.S. consumer has distinctly, materially deteriorated in terms of availability of disposable income (both savings and cash flow in excess of debt service), stability of income streams (stable employment – ongoing rises in national unemployment figures), eligibility for consumer credit products (due to debt-to-income and credit score considerations), access to credit products (tighter underwriting standards from credit issuers and the reduction in consumer credit limits on a variety of consumer credit products). It is a reasonable expectation is that this deterioration in the U.S. consumer’s capacity will continue for the next decade or so.

Once again, I believe the current socio-economic/socio-political dialogue that references the capacity of the re-emergence of the U.S. consumer is laden with an outdated definition, bereft of the reality of the substantive damage the actual U.S. consumer has incurred in this recession, since 2007. Furthermore, I believe inertia exists within the arena of economics that persists in perpetuating a long-held, widely shared concept of the attributes and potential propensity U.S. consumer to jumpstart economic recovery – a concept that is outdated, deceptive, and fails to appreciate the reality of the current economic attributes of those labeled as such.

Joshua Cooper Ramo provides an illustration of my point here, when he writes in his most recent book, The Age of the Unthinkable – Why The New World Disorder Constantly Surprises Us And What We Can Do About It:

“The explanation for this shared wrong view — you had to call it a delusion really — was social rather than factual. People agreed because they wanted to be part of the community more than they wanted to be right. It was a situation you could find echoed around the world in foreign policy or finance in 2008: a set of shared, wrong ideas, clung to loyally by people who couldn’t quite see past their illusions or the imagination-killing need to agree and fit in.”(5)

What is essential is for the economic intelligentsia in academia and private enterprise to embark on re-assessing how the capacity of the present day U.S. consumer differs materially, substantively from those who have comprised the term in previous historical eras. Furthermore, they must then inform us as to how this capacity can be restored to contribute strategically to recovery. As Nassim Nicholas Taleb says, “Awareness of a problem does not mean much — particularly when you have special interests and self-serving institutions at play”(6)

4. There sheer numbers and historical prowess of   U.S. consumers consistently referred to as the economic engine of the U.S. have been distinctly wounded and impaired during the ongoing recession.  Without immediate and meaningful repair, both their numbers and capacity are likely to continue to dwindle for several decades.

Time Magazine wrote in their June 10, 2009 issue:

“American consumers, whose overspending largely got us into this mess, are still under massive pressure, owing to the record debt they racked up during the boom years. People are unwinding those burdensome obligations — from mortgages to car loans to credit-card debt — as fast as they can, but the process is sure to take years, and until it is complete, the economy can’t fully bounce back. “(7)

According to Time’s sources, In April 2009, unpaid consumer credit — limited solely to credit cards, auto loans and tuition-financing — fell by $15.7 billion to $2.52 trillion. This would be a 7.4% drop on an annualized basis and perhaps, seemingly, the second largest dollar drop on record — right after March 2009’s  $16.6 billion reduction. What those figures do not tells us about are the reductions that were a function of non-payment by U.S. consumers and thus, write-offs/write-downs by their credit grantors.

Gluskin-Sheff’s Chief Economist and Strategist David Rosenberg writes: “Even though we’re probably past the worst in the business cycle and probably even in the bear market, we’re talking about something much bigger here. The largest balance sheet in the world is the U.S. household balance sheet, and it’s contracting at a record rate.  — The ratio of debt to income increased from about 35% in the early 1950s to about 65% by the mid-1960s, where it more or less stayed until the late 1980s. That’s when debt started its epic rise, hitting 100% of income in 2001 and going all the way up to 133% in 2007.” (8)

U.S. consumer confidence declined to a four-month low in August 2009, due primarily to ongoing additions to the unemployment rolls. Even though spending rose humbly in July 2009 (driven primarily by “Cash for clunkers”), this suggests that the recovery from recession will be protracted and sluggish. Incomes have been flat, and disposable incomes (after debt service) continue to decline. The U.S. savings rate has not increased substantially, adding further pressure on families, when coupled with falling home prices and rising unemployment.

According to John Silvia, Chief Economist for Wells Fargo Securities, “The current path of employment dramatically lags the path … of the prior seven economic cycles, Here’s how dramatically: The number of jobs in the US has fallen by about 5 percent – or 6.9 million – since the start of the recession in December 2007. In the prior seven recessions, on average, the number of jobs was down by 1 percent.”(9)

According to Bloomberg’s John Wasik – “The loss of some $7 trillion in household wealth is an albatross around the neck of the economy. This dour effect is clipping a robust recovery. Millions who have little or negative home equity are shackled to houses they can’t sell and a debt burden that keeps them from moving ahead. They can’t save, either, although they desperately need to boost their cash reserves.”(10) Another observer puts it this way: “About $7 trillion has been taken from the wealth account of property owners. If there are 130 million housing units in the United States (rental and owner occupied), then owners have lost an average of $54,000 per unit they own. The loss is massive. Foreclosure sales are a leading source of falling values. Payment performance on mortgages is terrible and getting worse. More than 4% of mortgages are in foreclosure. More than 13% of mortgages (ONE IN EIGHT) are behind. There is no indication of a turn-around in current payments on mortgages. How does optimism make sense of this payment history?” (11)

The Wall Street Journal reported (Improving Home Sales Belie Market Reality, 8/21/09) that two-thirds of residential homes sales in the U.S. are currently some form of distressed sale. (12) “Think about that for a minute,” John Mauldin of Millennium Wave Advisors wrote recently. “Two-thirds of home sales are either foreclosures or banks taking a loss on the mortgage. And only a third of the remaining one-third — roughly 10% of overall sales — comes from ‘something we could call a normal selling process.”(13)

Finally, Michael David White – In his article Debt Man Walking writes, “we are a country with perhaps 20% of our households heavily overleveraged. Their failed-gold-rush balance sheet will lead to unprecedented mortgage and credit card defaults.” (14)

Summary:

So here we are – considering and age old formulaic concept for economic recovery — one in which a key component of the equation has distinctly morphed – it’s changed. R=MC2Recovery and the Misunderstood Consumer Conundrum.

In their new book, George Akerlof and Robert Shiller suggest that:

The confidence of a nation, or of any large group, tends to revolve around stories. Of particular relevance are new era stories, those that purport to describe historic changes that will propel the economy into a brand new era.” (15)

Akerlof and Shiller go on to state: “Confidence is not just the emotional state of an individual. It is a view of other people’s confidence, and of other people’s perceptions of other people’s confidence.” (emphasis is mine) (16)

Stories, changes, a new era, emotional states, perceptions — confidence — all terms that John Maynard Keynes might point to as sources of explanatory power for economic fluctuations and the instabilities that inhabit capitalism. Keynes, Akerlof and Shiller refer to these influences as animal spirits.

The U.S. consumer, the resilient, economic animal that is said to power this economy, and provide the impetus that shall lead us out of the current economic doldrums, is wounded and restless.

Perhaps this article shall provide some motivation to move beyond the trillions in U.S. government investment directed at stabilizing systemic risk, and begin to strategize essential, overdue redress for the U.S. consumer.

—A voice overheard at the zoo:

That tiger looks worried, tired and hungry mommy — It doesn’t look healthy.

Perhaps you don’t have to be Einstein to figure this equation out. The energy (or lack thereof) within the U.S. consumer matters.

NOTES:

1.The Malaysian Insider – September 5, 2009 – U.S. Consumer Spending Up – But Morale Lowhttp://www.themalaysianinsider.com/index.php/business/36332-us-consumer-spending-up-but-morale-at-4-month-low

2. Lowenstein, Roger – When Genius Failed The Rise and Fall of Long Term Capital Management 2001 Randon House Trade Paperback Edition Copyright ©2000 by Roger Lowenstein, p. 59.

3. Taleb, Nicholas Nassim The Black Swan – The Impact of the Highly Improbable Random House, NY, NY Copyright © 2007 by Nassim Nicholas Taleb, p. 15.

4. Brafman, Ori and Rom – SWAY – The Irresistible Pull of Irrational Behavior – Doubleday – A Division of Random House, Inc. – New York, New York, Copyright © by Ori and Ron Brafman.pp. 74-75.

5. Ramo, Joshua Cooper – The Age of the Unthinkable – Why The New World Disorder Constantly Surprises Us and What We Can Do About It by Joshua Cooper Ramo. (Copyright © 2009 by Joshua Cooper Ramo – Little, Brown and Company New York, NY). P. 62.

6. Taleb, Nicholas Nassim The Black Swan – The Impact of the Highly Improbable Random House, NY, NY Copyright © 2007 by Nassim Nicholas Taleb, p. 47.

7. Time Magazine – June 10, 2009 – “A Drag on the Economic Rebound – Consumer Spending

8. http://www.gluskinsheff.com/

9. http://csinvestor.com/investing-guide/economic-bubbles/

10.  Bloomberg – Wasik, John – September 2, 2009 – Housing’s ‘Poverty Effect’ Fouls Up U.S. Rebound:

11.  White, Mike – writing in http://newobservations.net/

12.  Wall Street Journal 8-21-09 – Improving Home Sale Belie Market Reality –    http://online.wsj.com/article/SB125081143925447971.html

13.  John Mauldin – Thoughts from the Frontline

14.  White, Michael David – Debt Man Walking – July 17, 2009 http://newobservations.net/2009/07/17/debt_man_walking/

15.  Akerlof, George A. and Shiller, Robert J. – Animal Spirits – How Human Psychology Drives the Economy, and Why It Matters For Global Capitalism, Princeton University Press Princeton, NJ USA and Oxford, UK Copyright © 2009 by Princeton University Press, p. 55.

16.  Ibid., p. 55

Lake Chapala – Beneath the Surface

One thought on “R=MC2 Economic Recovery and the Misunderstood U.S. Consumer Conundrum”

  1. Bill,
    You ask: How we are doing? How about this?
    On the financial side, it is truly ugly and I am a poster child for your very thoughtful analysis of the American consumer. (With the exception that my money has not gone for toys or high living – it has gone into business investment.)

    I absolutely agree that the US is not going to, as in the past, recover once again without some big time pain. Where is the real need? It is jobs and how do you create new jobs with the Chinese supplying everything forever? I tell my friends to just expect a reduction in the standard of living. OK, how about 1 car per family. How about 1 bathroom in your rented house? How about less of everything that we now enjoy.

    One example: I owe National City Bank $367,000 on a second mortgage on my house. After 10 months of buying groceries and paying health insurance instead of paying on this mortgage, National City calls me and says: “We will give you ZERO INTEREST for the life of this loan and lower the monthly payment by 50 percent!” I said thank you but I would also like a 75 percent reduction of principal. Otherwise you can pay off the first and probably drop another $500,000 when you sell the house.

    Am I proud or ashamed of this black hole I have dug. No, as I have gone forward – believing in the past as predictor of the future as your analysis implies. I used money to invest in businesses I thought would pay off big. None of them have failed but they are directly linked to the overall economy and are, therefore, struggling. My goal is to weather the storm – by whatever Guerrilla tactics I can muster. We will see.

    I have had 5 friends in the last year lose their spouses….. So what could I possibly complain about? It is true that if you have your health – you have everything.

    All the best to you. Keep the analysis coming. You are on the mark.
    Best, Big Mac

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