Consumers Decide Enough is Enough

Questions about why the recovery is so slow have cropped up lately.  Economists and strategists alike are baffled by the sluggish nature of this recovery, particularly considering our previous experiences after deep recessions.  The answer this time around may be very simple – consumers are unable or unwilling to leverage their personal balance sheets – constraining spending and hampering the economy in ways previously unseen.

Two weeks ago, the Federal Reserve Bank of San Francisco released the most troubling paper on this development.  In its paper, the FRBSF found that, resulting from the 2008 recession, consumer spending per person was $7,300 less per year than would otherwise be expected.

Citing an “accommodative interest rate environment, lax lending standards, ineffective mortgage regulation, and unchecked growth of loan securitization,” FRBSF determined that consumers underwent one of the most expansive credit binges in history prior to the recession.

The household debt service ratio, as an example, jumped from 12% at the start of 2000 to near 14% by the end of 2007.  While this is a small percentage increase on the surface, it masks the fact that total consumer debt grew by 152% in that period.

It is often said that a rising tide lifts all ships, and never was that more true than during the middle of the last decade. As consumers embraced debt in its many forms, household net worth also benefited, growing at an exponential pace.

On a non inflation-adjusted basis, household net worth grew from $44 trillion in 2000 to $62 trillion by the end of 2007.

Unfortunately, just as quickly as it came, it disappeared.  From the end of 2007 through the end of 2008, more than $12 trillion of net worth vanished.  The market rally in the ensuing years brought back some sense of normalcy, but the damage was already done, particularly because net worth is not recovering as quickly as in previous recessions.

Not only was the decline in net worth more severe, but the recovery has been far below the prior two recessions.

When the FRBSF charted pre- and post-recession trend rates for consumer spending, it found that consumers spent $175 less per month on average after the recession.

Sadly, the story does not end there.  In a simple chart titled “End of the American Dream,” Reuters columnist John Kemp demonstrated why American consumers are in for a long, arduous recovery.  Spending on basic goods such as food, energy and clothing is reversing its multi-decade slide.  Food and beverage costs alone fell from 25% of consumer spending in 1948 to well below 10% in recent years.

During previous recessions, consumer spending was bolstered by the declining cost of basic goods.  This allowed consumers to shift money to discretionary spending, effectively propping up the economy.  Those days appear to be behind us, as costs for everyday staples are beginning to trend higher.

Repeatedly, the economic recovery has relied on the consumer.  That is simply not going to happen this time around, due to any number of factors from excessive unemployment to an unwillingness to increase borrowing.  We should all prepare for the realities of a long, sluggish recovery without the stimulus of consumer spending.