I recently attended a conference at which the speaker indicated that, since roughly 70% of GDP is consumption, the stimulation of consumption is necessary for full economic recovery and the resumption of robust growth.The logic was as follows: Rising consumption means more goods and services are consumed making it necessary for businesses to produce more. This implies the need for more labor, and therefore an expansion in the number of jobs. More jobs means higher incomes which means more consumption etc. In all of the post-WWII recessions, this logic worked as those recessions were basically inventory corrections or caused by one-off events. The current economic malaise, however, is more like the Great Depression than any of the post-WWII recessions. Like the Depression, this one was caused by bursting asset bubbles, high debt levels, and stagnant incomes, not only in the U.S., but in most industrial economies. Thus, this is not a typical inventory correction cycle. The model described above generated the idea expressed around the TARP legislation that we had to save the mega-banks because "credit is the lifeblood of the economy." As those banks have shown us over the past year and a half, loans outstanding have fallen every month. And clearly as the consumer mortgage and credit card write-offs have shown, many U.S. consumers are not all that credit worthy. The table below is a hypothetical comparison of two California families, each with one breadwinner making a $100,000 annual income, and 2 children. Family A purchased a home for $250,000 and has a $200,000 5% 30-year fixed loan. They have one car that is financed and no credit card debt. Family B got caught up in the housing bubble and purchased a home in '05 for $410,000, has a $400,000 5/1 ARM with a 5% teaser rate that resets to 4% on 7/1/10 and is fully amortizing over the remaining 25 years at reset. Every six months it is subject to a new reset based on its underlying index. The home's value is less than the mortgage, so refinancing is not an option. This family has 2 cars fully financed and credit card debt of $20,000 which was from cost to landscape and a vacation to an exotic destination. The prospects for wage increases for both families over the next few years are almost nil with prospects of wage and benefit cuts looming. Neither family is well off, but if Family A consumes its remaining income ($797/week -- see table) in exactly the same way as Family B ($558/week), it can at least save $12,428/year for retirement. In my first scenario, a very likely one, the Bush tax cuts are allowed to expire and California taxes rise 10%.
Scenario 1: Expiration of Bush tax cuts and CA income taxes rise 10%
Scenario 2: Moderate increase in interest rates
Family A:No change from Scenario 1