February 27, 2009
THE GREAT UNWINDING
No one expected good news, and the expectations were met.
Today's update on 2008's fourth-quarter GDP was ugly, the ugliest in 25 years, in fact. The economy contracted by 6.2% at a real, annualized seasonally adjusted pace in the last three months of 2008. That's much deeper than the 3.8% decline originally estimated by the government.
Painful, but no one should be shocked, given the general economic and financial climate. But let's be clear: the embedded message in today's revised numbers from the Bureau of Economic Analysis is sobering. The principal reason it's sobering is that the main driver of economic activity has stumbled and the prospect for a quick turnaround is about as likely as waking up on the surface of Neptune tomorrow.
It's not an exaggeration to say that consumer spending has hit a wall and crumbled as a result. Perhaps the only surprise is that it took so long for a retrenchment in consumer spending habits. But fate can only be delayed so long. The willingness, bordering on obsession for borrowing in 2002-2007 has finally come back to haunt Joe Sixpack, and by extension the wider economy, which is heavily dependent on personal consumption expenditures. The implosion of the financial industry has, of course, exacerbated the trend, as has the collapse of the real estate bubble. In short, a perfect storm, the effects of which are only now being fully realized.
America has long been a nation of consumers, and there's much to cheer about on that front. Consumption generates economic growth and spending has been no small part over the generations in powering the American dream of building wealth and prosperity. But there's a limit to everything, and at some point even a good thing becomes excessive. At some point in the recent past that limit was breached.
Excess certainly looks like an appropriate label for consumer borrowing in 2002-2007, when the household balance sheet became laden with debt to an extent that was as shocking as it was fated for a day of reckoning. The details are there for anyone willing to take the time and pore over the Federal Reserve's Flow of Funds Report.
The reaction to the mountain of debt is now underway. As our chart below shows, consumers are finally facing facts and cutting spending. If a purchase can be delayed, it will be; if spending can be minimized, it is. No wonder, then, that durable goods spending—the so-called realm of "big ticket" items like washing machines and refrigerators—is falling rapidly. If you don't need it, you don't buy it—the new mantra of for a new generation of consumers who've been dragged kicking and screaming to this revelation of unvarnished necessity. Only services spending has been spared, which is largely a function of essential services like medical purchases in this category.
The bottom line: consumers are aggressively repairing their balance sheets after a long stretch of doing the exact opposite. The front line in the restoration is cutting spending, anywhere and everywhere. This process has only just begun. Given the magnitude of the former excess levels of spending and debt creation, the mending of household balance sheets will run on for some time, probably for far longer than is widely expected. The repercussions will be far and wide. It's not the end of the world, but it is the start of a new era that will reorder the consumer mindset.
Exactly how long this pullback rolls on is the question. For now, it's clear that the unwinding is upon us, and the worst of it is going to roll on for several quarters, perhaps several years. It's a process that's long overdue, fundamentally necessary and destined to be painful. Coming to terms with reality is never easy, but it is refreshing and healthy…eventually.
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Posted by jp at February 27, 2009 9:43 AM
Excellent analysis. Unfortunately, what is very healthy for household balance sheets is terrible for the economy as a whole. Just as we collectively erred on the side of irresponsibility during the period you cited, we are likely to excessively hoard in the future. Those that can afford to spend $100 for example, may choose to only spend $50. Extrapolate that throughout the economy and the effect on growth is obvious.
Posted by: Dave at February 28, 2009 7:13 AM