Monday, May 14, 2007

Stretched US consumers

I am an economics junkie as well as a foreign policy junkie. Last week I admitted that one of my mistakes analyzing foreign policy is my former expectation that the GOP would react in a politically coherent fashion by running away from President Bush and the politicalized war of Iraq. That strategy would have made sense from November 8, 2004 to today but it has not happened. Another mistake that I have been making in economics is an expectation that the American consumer and more importantly the American borrower would be tapping out. Income gains for most Americans have been mediocre at best for the past five years, employment to population ratios are not strong, and the hard to shift costs of living have been increasing far faster than general inflation or wages.

And yet, the American consumer has continued to go deeper into debt. First we handled it by deluding ourselves that the fundamentals of the housing market had magically changed. This allowed a significant segment of the population to borrow and cash out significant equity to fuel a consumption binge. And more recently, all terms of debt have been relaxed. This is a behavioral pattern which is acceptable and healthy for a retired population and not for one that is still the a demographic sweet spot where we should be saving for retirement and creating more productive uses for our money. Instead we bought McMansions and inflation-mobiles.

I may be wrong yet again on this, but it does look like the marginal American consumer is looking to retrench. The first number that jumped out to me was the April retails sales data. One data point is never a trend, especially for a high MOE number, but this is the second month in a row of declining sales. Furthermore, housing prices are beginning to see year over year declines combined with lower volumes of sales. There is less money and cushion in the economy to provide any last reserves of easily tappable spending power.

Calculated Risk is passing along this interesting tidbit from the Chicago Tribune:

sales of new vehicles slipped nearly 3 percent last year to their lowest level since 1998 and are down the same amount this year.

Analysts and auto manufacturers cite several factors for the sales slide, including high gas prices, sagging home values and sluggish economic growth.

But those who study car-buying habits see another factor keeping a lid on car sales: the aggressive borrowing habits of consumers today.

They say borrowers have stretched out their car loans over such a long period of time that some can no longer afford to replace their vehicle.

"They would like to trade, but they can't. They have no equity," said Art Spinella, president of CNW Marketing Research, which studies consumer buying trends.

Three out of five new-vehicle loans made this year, or 60 percent, are for 61 months or longer, and nearly 20 percent are for longer than six years, according to a Consumer Bankers Association study. Some go as long as 96 months. . . .

The recent past mortgaged its flexibility to consume in the near future which has become today for a short term boost in living standards and consumption. The flexibility of being able to shift consumption, savings and spending has been systemically eaten up over the past five years so if there is any significant shock to the system, resiliency is way down as the system has become much more brittle.

Gasoline prices could be one of those shocks. Right now we are nominally above the Post-Katrina spike in gasoline prices nationally with two weeks to go before the summer driving season starts. This is despite refinery production being up and increased use of non-petroleum feedstock. So in a fairly favorable set of circumstances, prices are at nominal record highs and are within a couple of percent of reaching their real local maximas. If anything goes wrong such as an increase in sabotage activity in the Niger Delta, a minor refinery fire a pipeline breaking due to maitenance problems, an increase in southern Iraqi oil systems disruption or generic corruption or who knows what other probable negative events will send a significant price shock.

Gasoline prices are just one of the many things that the typical American consumer no longer is able to maintain any reserves against that are not directly tied to running out the credit card one more time. Sooner or later, this can not be good for the economy even if the top line growth and inflation numbers are perceived to be good.

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