Tuesday, December 1, 2009

Is the US consumer overleveraged?

Readers of this blog will be aware that my view is one where the US consumer is over-indebted on a structural basis, the savings ratio will rise and consumption growth will be muted for a prolonged period of time. Consumption growth is being determined by the growth in disposable income and changes in the savings ratio. The outlook for disposable income growth remains poor (see for example Small business job creation, personal income & consumption: weak dated October 7). Furthermore, amid the rising unemployment rate and the previous drop in house prices, the creditworthiness of a large sum of households has deteriorated significantly and the propensity to incur new debt has been reduced while banks on the other side remain unable and unwilling to lend. In turn, the savings ratio is likely to trend higher.
However, J. Wilmot, chief global strategist at Credit Suisse, suggests in FTs Alphaville blog that the idea of the US consumer being overleveraged and that it may take a decade to unwind the damage "is the most overbought idea coming out of the current crisis".
His argument is the following:
"Everyone is by now familiar with the first chart below, but few know the second one, which we find much more informative. Essentially it shows that, although leverage ratios increased in the Greenspan era for all income groups, it is really only the bottom 20% of the income distribution who have clearly borrowed more than they can afford to service. And it is these higher income groups who account for 90% of US consumption. So the debt issue is arguably as much or more a major social and political problem as an economic disaster."



He goes on: "The debt story is really about the cyclical vulnerability of consumer spending, not a structural obstacle to future spending that matters even when income grows. The distinction is critical. Full recovery of consumer spending can occur with house price stabilisation and a return of income growth. It has little to do with getting the savings rate or debt-income ratio to certain levels."

I disagree with this view.
a) That the weakness in consumption is more pronounced than during the average recession is highlighted by the chart below (taken from Will consumption growth return to its pre-recession level? by Mark Thoma). To quote: "This graph compares the movements in aggregate real consumption during and after the onset of the current and three most recent recessions. The graphs show the first month of a recession as defined by the NBER — normalized to 1.0 to facilitate cross-recession comparisons — and the subsequent 22 months after the recession begins (for a total of 23 months, the length of time since the current recession began)"
He goes on:" First, in every other recession consumption returned to close to its pre-recession value no longer than 9 months after the recession started. Second, the drop in consumption has been larger and more sustained than in previous recessions. The drop in the 90-91 recession was nearly as large, but nowhere near as sustained as the present case."
This comparison with other recessions highlights that there is more to the weakness in consumption than just "cyclical vulnerability".


b) "it is really only the bottom 20% of the income distribution who have borrowed more than they can afford to service": According to this data, 1 in 8 American (12%) currently uses food stamps. The increasing usage of food stamps to me suggests that those people will not have a lot of money left to help drive consumption growth. But it is not only in the bottom 20% as Wilmott suggests that high indebtedness is prevalent. The chart he uses also shows that for all income groups except the top decile, indebtedness grew significantly over the past years and stands at roughly 170% (up from less than 100% just 20 years ago). Now also 170% sounds high to me and the rise of in the indebtedness over the past decades shows just by how much the rise in consumption was debt-fuelled. If that growth in debt can not be sustained, so cant be the growth in consumption. Wilmot states that it is only the bottom 20% who have lived beyond their means, however, his chart suggests that only the top 10% have lived within their means!
Additionally, as Richard Green argues here: "The counter-argument is that average household net worth relative to GDP remains quite normal by historical standards. But here is where the skewed distribution of wealth is a problem. I am reasonably sure that when the next Survey of Consumer Finances is released for 2010, median household net worth will be down. Corelogic says that one in four households with mortgages has negative home equity--this would be about 18 percent of owner households (about 30 percent of owners have no mortgage). If we combine this with the fact that 1/3 of the country rents, this means that the median households has little or no home equity. The median household is not loaded with financial assets, either. According to the 2007 Survey of Consumer Finances, only half of families have a retirement account, and only 21 percent owned stocks. Put this all together, the median household is not in great shape financially, and the median household consumes a higher share of its income than higher income households."
I do not see anything in Wilmot's argument which would make me change my view of a prologed period of limited consumption growth in the US.

1 comment:

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