The harsh reality is that the once-mighty US consumer is setting out on a long, debt-reduction marathon that will mute economic recovery in America and among its major trading partners. No wonder folks like Pacific Investment Management Co Chief Executive Officer Mohamed El-Erian were talking in recent weeks of a new normal of 2% or less for US economic growth.
The issue with consumers: Their balance sheets are a bloated mess with household debt still unsustainably high at more than 130% of income.
Getting the ratio down to a more realistic sub-100 percent level never mind the 60% to 70% range seen in the 1960s and 1970s involves serious consumption cutbacks. With consumers accounting for about 70% of the US economy, this one-time engine of growth may easily become a dead weight.
That surely undermines hopes for a V-shaped economic recovery, as well as a belief that stocks have entered a broad new bull market since hitting bottom in early March.
At the least, it calls into doubt moves like the almost-50% rise from March lows in some funds that track consumer discretionary stocks, the kind of companies that shine when people do more than just hoard canned goods and bottled water.
New growth needed
Essentially a world accustomed to relying on the strength of the US consumer now must look to a new source for growth, Jeffrey Rosenberg, credit strategist at Bank of America-Merrill Lynch, wrote in a report earlier this month. The problem with consumers balance sheets was a long time in the making, so it shouldnt come as a surprise that a resolution wont be quick or easy.
The US household debt had been growing at a faster clip than incomes since 1960. The trend grew more worrisome in the 1990s, though things didnt get completely out of hand until the start of this decade.
Low interest rates, funky new mortgage products and an overall lowering of lending standards led to a borrowing binge that wrecked household balance sheets. Undoing that will be painful, at least based on past experience. That was the finding of a mid-May research note by Reuven Glick, group Vice-President, and Kevin Lansing, senior economist, at the Federal Reserve Bank of San Francisco.
The two researchers looked at the experience of non- financial companies in Japan, following the bursting of that countrys stock-market bubble in 1989 and real-estate bubble in 1991. It took those companies 10 years to reduce their debt-to-gross domestic product ratio from 125% to 95%. During that time, the companies had to change from being borrowers to savers.
For the US households to cut their burden similarly, the debt-to-income level would need to drop to 100% by 2018, Glick and Lansing wrote. And for that to happen, household savings rates would need to rise from around 4% currently to 10% by the end of 2018.
The upshot of that would be a reduction in the consumption growth rate meaning consumers would buy a lot less stuff. This would result in a substantial and prolonged slowdown in consumer spending relative to pre-recession growth rates, Glick and Lansing wrote.
There are some equally unpalatable alternatives. Rather than save their way out of debt, consumers could default their way out of it. That would cleanse personal balance sheets, yet transfer losses on homes, credit cars and cars to banks. In that case, the economy again would face headwinds as banks husband capital to deal with losses, reducing their capacity to lend.
Another possibility would be for households to rely on rising incomes to bring debt down to the more sustainable level of about 100% of income.
Its tough to see that happening anytime soon, especially with the US unemployment rate at 8.9%. In fact, many people now expect their incomes to fall, not rise.
People are used to going to their bosses and asking for a raise and that is not happening anymore, said Jonathan Basile, an economist at Credit Suisse Group. Falling incomes lead to the collective creditworthiness getting worse, he added. Couple that with crimped lending by banks, and consumers face a sea change in terms of their use of debt, Basile said. So too do the businesses, and countries, who came to depend on the US consumer regularly splurging on everything from flat-screen TVs to granite countertops.
That doesnt leave much room for confidence.