Friday, July 14, 2006

Is the consumer starting to crack? From minyanville.

consumer cracking?

One thing we Americans will never be accused of is self-restraint. Faced with entreaties to “eat all you can eat”, “shop til you drop” and “SuperSize It”, we are powerless to resist…and we’ve got the bloated balance sheets and physiques to prove it. After stuffing ourselves silly over the last few years, however, it appears some of us have finally had enough. The latest retail roundup reinforces what we suspected all along-- the U.S. economy is starting to get a little soft around the middle. Sure, things at the high-end are still quite firm. But our middle-class gut has definitely started to head south. As the nation’s midsection succumbs to gravity and the lower-income ranks begin to swell, mid-tier retailers and dining establishments are feeling the pinch.

After kicking and banging their household ATMs to deliver any cash still trapped inside it appears the jig is finally up. Combing through the Fed’s Commercial Bank Assets release last Friday (must reading for insomniacs) we made a most shocking discovery. Transaction deposits (aka checking accounts) at banks plunged -$30b in one week and are down -8.4% y/y, their lowest level since the last recession. Gee, might this evaporation in deposit balances foreshadow a slowdown in discretionary spending ahead? Sure looks like it…

Yep. Things are sure starting to look dicey on the consumer front. And no wonder, our promised safety net -- income growth -- is fraying before our eyes. Loath as we are to rain on the wage inflation parade, the surge in Average Hourly Earnings in last week’s Payroll Report likely owes more to mix shift than spontaneous beneficence on the part of Corporate America. The return of a handful of manufacturing jobs (which tend to be higher paid) buoyed earnings. The same thing happened in April only to reverse course in May. But this is a fairly minor quibble. The real issue is that wage growth continues to lag inflation. And that’s using the government’s inflation gauge. One shudders to imagine what the ‘real’ real wage picture looks like!

Interestingly, the last few times U.S. consumers found themselves in this infelicitous situation, housing booms were also providing an income cushion. In each case, asset inflation mooted lackluster wage growth…for a spell. Once the boom ended, however, the lack of wage growth began to matter and recession promptly ensued.

Which brings us to today. With no more equity to tap, day-laborers are struggling to finance larger mortgage payments, higher credit card minimums and $3/gallon gasoline with skimpy wage growth. And if you think they’ve got it bad, imagine how those with ZERO wage growth feel! I’m talking about the senior set. Trying to keep up with the rising cost of living (which is particularly punitive when you consume an outsized share of healthcare where inflation is most rampant) with the income generated from 40-year low interest rates has to be tough. One could forgive them for being a little crotchety. Just how strapped our fuddy-duddies have become was made clear in the MBA’s recap of 2005 mortgage activity released earlier this month. It revealed that reverse mortgage incidence mushroomed 45% in the latter half of 2005 from the first six months of the year! It is mind-boggling that this hasn’t received greater attention. I guess it’s naptime at the AARP. Zzzzzz…

No matter. The issue will take centerstage soon enough when the government finds itself forced to bail out strapped consumers in general and these retirees in particular. It was always inevitable that the baton would be passed from monetary to fiscal policy. As the fruits of Greenspan’s asset-dependent economy begin to sour, fiscal policymakers will hasten to provide alternate sustenance.
At a minimum, a slowdown in the 70% of the economy that the consumer represents will boost cyclical outlays. (I mean, having deposit balances contract -8.4% at a time when mortgage payments are up 15% is bound to take a toll). But we fear the spending won’t stop there. The housing bust may be met with more direct government assistance. After all, should homeowners find themselves owing more than their home is worth, they might decide to mail in their keys rather than their mortgage payments. This could seriously weaken the banking system. (As we’ve pointed out repeatedly, banks have record exposure to real estate via direct mortgage loans and MBS holdings). So, why take a chance? Why not just bailout those homeowners on the brink? Besides, the government surely feels some culpability since Fannie (FNM) and Freddie (FRE) helped put us in this situation. So, enjoy the budget celebration while it lasts. It won’t be long before this trend reverses…and meaningfully. The Great Housing Bubble will be followed by the Great Government Bailout and our budget deficits will go from bloated to morbidly obese.

As consumer spending slows and Washington grows, our financing needs will rotate…

The million-dollar question, of course, is: Will our foreign financiers care? Will they finance our expanding public sector liabilities with the same alacrity they did trade?? To the extent that the lion’s share of our capital flows are now coming from private sector institutions stretching for yield, the answer would seem to be ‘no’. After feasting on sophisticated asset-backed exotica and derivative delicacies it seems unlikely these folks will dull their palates with our public sector pork. Of course, when credit risk mounts its return this paper, too, will lose its allure.

Never fear, we’re assured, the return of risk will simply send our foreign financiers back to the ‘safety’ of Treasuries. After all, they’ve still got to put their forex dollars ‘to work’. Sigh. Such is the arrogant assumption made by most US-based investors. As if this were a binary decision---have dollars, must recycle. There are, in fact, two options for dollar holders: invest or spend. Increasingly our financiers are opting for the latter.
Topping the list of places to spend their dollars is oil. We’ve made the point repeatedly that a ‘cold war’ for energy resources would provide material competition for US financial assets. But perhaps now, after seeing oil stand unharmed amid the mayhem and destruction in May, the point will command more respect. So, let’s review: At the margin, dollars that used to be recycled into US assets are now being used to buy energy security. This is creating a feedback loop as, the higher oil prices go, the less compelling it is to vendor finance US consumers. (Because the marginal benefit of printing money to lend to US consumers is now being offset by the ‘tax’ associated with paying higher dollar-priced oil). In fact, we appear to be at a critical threshold. With a $10 annual increase in the price of oil sucking $300b from oil consuming nations’ pockets, it takes a $20 increase to offset the $600b global trade with the US. Over the last year, oil is up $18. Obviously, US import growth slows (as it is now), the math becomes even less compelling.

Oil isn’t the only thing our former financiers are spending their dollars on. They are also hard at work trying to create their own consumer-economies. This kind of change doesn’t happen overnight. Actually, with $900b in cash on hand (China’s forex reserves) it might! But, it clearly isn’t going to be accomplished by sending dollar reserves to the US Treasury.
At the same time our Asian financiers are starting to use their dollars to buy economic independence rather than US Treasuries, their consumers have also stirred to life. In Japan, consumer confidence is the highest in twelve years. Real wage growth is positive and bank lending just notched its largest increase since 1996. Meanwhile, in the US, confidence is generally eroding, real wage growth is negative and home equity lending is contracting year on year.
So, while the US has been the favored place to ‘put dollars to work’ over the last several years, that may be about to change. As the US housing boom turns to bust and our consumers downgrade from prosciutto to pork rinds, it seems unlikely our creditors will do the same.


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