By Mike Whitney
Two and a half years have passed since Lehman Brothers collapsed and US consumers are still digging out.
Last Thursday, the Fed released its “flow of funds” report which showed that households had trimmed their debt to $13.3 trillion in the forth quarter (4Q). But the crucial debt-to-income ratio remains significantly above trend at 120.9%. That means that consumers will have to cut back spending even more.
During the boom years, (2000 to 2007) households more than doubled their debt by taking advantage of cheap, easily-available credit for purchasing mortgages, refinancing homes and maintaining their standard of living. Homeowners were able to drain (roughly) $500 billion per year from their rising home equity to spend as they pleased. The credit-binge stimulated demand, increased employment, and created a virtuous circle of profitability and growth. But now the process has slammed into reverse triggering a wave of foreclosures, bankruptcies and defaults. Consumers have been retrenching for 11 straight quarters trying to patch their balance sheets after sustaining heavy losses during the crisis.
Household deleveraging can have a devastating impact on the economy because consumer spending is 70% of GDP. Fortunately, the Obama administration initiated a $787 billion fiscal stimulus package to make up for the shortfall in private sector spending, otherwise the economy would have slipped into a long-term slump. Government spending (the deficits) pulled the economy out of recession, reduced the gaping output gap, and increased employment by an estimated 2 million jobs.
Economists look to the flow of funds report to gauge the health of consumers, but sometimes the data can be misleading. For example, household net worth increased by $2.1 trillion to $56.8 trillion by the end of 4Q, but virtually all of the gains were in the stock market so it won’t effect the spending habits of people who aren’t invested in equities. As Barron’s Randall Forsyth notes, “You have to be in the lottery to win it.”
Still, Fed chairman Ben Bernanke sees rising stock prices as a sign that his bond purchasing program (QE2) is working. Like former Fed chairman Alan Greenspan, Bernanke believes that the “wealth effect” can boost spending and lead to recovery. Regrettably, the facts do not support Bernanke’s claims. While the administration’s fiscal stimulus increased economic activity and employment (according to 2 separate reports by the nonpartisan CBO), QE2 has merely inflated stock prices. There’s nothing in the flow of funds report that suggests anything more than a normal cyclical recovery following a deep recession. In other words, QE2 is a bust.
The Fed’s main policy tool is interest rates. QE2 is an attempt to push rates below zero by large-scale purchases of Treasuries. The goal is to spark investment in riskier assets. And, to some extent, it works. Thanks to Bernanke’s QE drip-feed into the banking system, stocks have climbed 12% in the 4Q. But higher stock prices haven’t led to greater investment or spending, just more liquidity sloshing around the financial markets. The problem is that QE2 has no transmission mechanism for getting stimulus into the real economy. It doesn’t increase wages, expand credit, or remove the red ink from household balance sheets. It just adds a few more gusts of helium to the equities bubble. This is apparent in last week’s Consumer Credit report as well as the flow of funds report. The Fed’s Credit Report showed that –apart from student loans and subprime auto loans–consumer credit is still shrinking. In fact, lending either stayed flat or dropped off at the commercial banks, finance companies, credit unions, savings institutions, nonfinancial business and pools of securitized debts. Bottom line: There’s no indication that the Fed’s policy is helping households reduce their debt or to resume spending at precrisis levels. In other words, QE2 is not paving the way to another credit expansion.
And then there’s this from Bloomberg Businessweek:
“Those ordinary Americans who have jobs worry about holding onto them, and they expect few if any increases in pay as the recovery inches forward. For upper-income households, it’s a different story, says Michael Feroli, a former Federal Reserve economist who is now chief U.S. economist at JPMorgan Chase in New York: “They’re the ones benefiting the most from the stock market rally, and they’re spending.”
….. Feroli estimates the top 20 percent of income earners account for about 40 percent of spending. Dean Maki, chief U.S. economist at Barclays Capital in New York, puts the figure at closer to 50 percent.”
So, yes, rising stock prices have been good for the rich who have resumed their trips to Tiffanys and their dinners at high-end restaurants. But for everyone else, it’s been a wash. The only thing that could change the situation is if QE2 pushed wages higher or lifted housing prices out of the doldrums. But it doesn’t work that way.
Here’s a clip from an article in the Wall Street Journal which sheds a little light on a part of the deleveraging story that’s missed by most of the media:
“U.S. families shouldered a smaller debt burden in 2010 than at any point in the previous six years….Defaults on mortgages and credit cards played a large role in bringing down household debt, underscoring the extent of the financial distress still afflicting U.S. families. Commercial banks wrote off $118 billion in mortgage, credit-card and other consumer debt in 2010, the Fed said. That’s over half the total $208.8 billion drop in household debt, which also includes new mortgages and credit cards….
Many consumers still have a long way to go to get their finances in order. Some economists believe a healthy household-debt-to-disposable-income ratio would be 100% or lower.” (“Families Slice Debt to Lowest in 6 Years”, Wall Street Journal)
So households are reducing their debt, but, what’s interesting, is how they are doing it. They’re defaulting. This is from an earlier Wall Street Journal article by Mark Whitehouse:
“The falling debt burden conjures up images of a nation seeking to repent after a decade of profligacy, conscientiously paying down mortgages and credit-card balances. That may be true in some cases, but it’s not the norm. In fact, people are making much more progress in shedding their debts by defaulting on mortgages and reneging on credit cards……on average, aren’t paying down their debts at all. Rather, the defaulters account for the whole decline, while the rest have actually been building up more debt straight through the worst financial crisis and recession in decades.” (“Number of the Week: Default, Not Thrift, Pares U.S. Debt”, Wall Street Journal)
Uh oh. So consumers are defaulting rather than paying-down their debts. That means more foreclosures and bankruptcies leading to larger losses at the banks and, perhaps, another bailout. It also increases the likelihood that stock and commodities prices will drop sharply when activity slows triggering another bout of deflation. So, can QE2 reverse the trend and ignite a flurry of investment and spending by tweaking the yield curve on US Treasuries? Don’t bet on it. Just take a peak at this article by Mark Whitehouse and it’s easy to see what’s going on:
“U.S. companies’ cash hoard keeps getting bigger, a trend both good and troubling. After hitting new highs in five of the last six quarters, nonfinancial corporations’ cash and other liquid assets reached $1.9 trillion at the end of 2010, according to the Federal Reserve. That’s 7% of all their assets, the highest level since 1963….the persistent growth of companies’ cash hoard suggests a problem: Businesses appear to lack the confidence in the recovery needed to plow the money back into new projects and hiring….. companies are giving some cash back to their shareholders through stock buybacks,….hardly a sign of optimism.” (“Companies’ Cash Hoard Grows”, Mark Whitehouse, Wall Street Journal)
So, why aren’t corporations reinvesting their $1.9 trillion stash when the Fed has lowered rates to 0% and Bernanke is supporting the markets with QE2?
It’s because of the lack of demand. Financial alchemy and waves of speculation have papered over the dismal performance of the underlying economy which grows more anemic with every business cycle. Businesses are no longer able to find productive outlets for investing their surplus capital, so the whole system is slowing down. And, when corporate savings are not recycled into the economy via investment, demand dries up. That’s what’s happening now.
Reformers can divert attention from the central problem by pointing at deregulation, low interest rates, and a foreign “savings glut”, but the fact remains that the recoveries get weaker and weaker, unemployment stays higher for longer, and the crashes get more catastrophic. All these point to a sclerotic and unstable system blighted by overproduction and underconsumption that is gradually succumbing to stagnation. The persistent slowdown is deepening inequality, inciting class antagonisms, and fomenting social unrest. Marx said that “the real barrier of capitalist production is capital itself.” The $1.9 trillion sitting idle on corporate balance sheets proves that Marx was right.