The End of Consumption

With evidence of a severe recession mounting, consumers are finally retrenching. At an individual level this all makes sense. Reigning in debt, spending based upon income, and saving for a rainy day will become commonplace. Thrift will be the new chic!

Stephen Roach in the NY Times writes:

Inflation-adjusted personal consumption expenditures are on track for rare back-to-back quarterly declines in the second half of 2008 at a 3.5 percent average annual rate. There are only four other instances since 1950 when real consumer demand has fallen for two quarters in a row. This is the first occasion when declines in both quarters will have exceeded 3 percent. The current consumption plunge is without precedent in the modern era.

Of course, there have been dozens of articles in the press lately about how these deflationary forces must be prevented by all means possible. People must be encouraged to spend, spend, spend. Wasn't this the cause of the problem? Americans can't spend 133% or their income indefinitely like governments. The Chinese economy has boomed in spite of and probably because of very high savings rates. Modern economics seems to have turned prudent personal finance on its head - all for the sake of the 'economy'.

There was a good article today in the Globe and Mail about the liquidity trap and why lowering interest rates will not work.

OTTAWA -- So what exactly have we learned in the last 300 years? In Britain's great financial crisis of the 1690s (a debased currency and an enormous trade deficit), it was John Locke, the famous philosopher, who counselled honest currency and legislative restraint. The merchant class clamoured for lower interest rates, as usual, to drive economic growth. When the government introduced legislation to set a maximum legal rate of interest (at 4 per cent, two percentage points less than the market rate), Locke denounced the reform as absurd. In practice, he said, it would reduce the supply of legal credit, increase the back-alley rate of illegal credit and (among other things) erode the incomes of "widows and orphans." People will always find ways, Locke asserted, to circumvent this kind of do-gooder regulation. His reasoning was efficient. ("Since it is impossible to make a law that hinders a man from giving away his money to whomever he pleases," he said, "so it is impossible to hinder him, by any contrivance of law, from the purchase of money.") People will do, in other words, what they will do.

The Japanese lesson of the last two decades is sobering. For any lasting recovery, I believe debts need to be serviced (or defaulted) before any new debt (spending) can occur. Because the current authorities are reluctant to allow this to happen and instead insist on sequential bail outs, we are destined to a prolonged and rocky period. I often don't agree with Neil Reynolds opinions, but he's right when he suggests that inflation (or reflation) can't occur without deflation first. Simple concept, but you can't go up without going down first.

In the last bull market, the bust of LTCM (1998) and the Tech bust (2001) was countered by more easing of interest rates and deregulation.

This is the image from the cover of Time magazine in 1999. With hindsight, we now know they blew sequential bubbles. Do we really need more of the same?