The Precarious Position Of The Us Consumer Marc Faber
Each time retail sales in the US increase and beat the Street's estimates by a small amount, Wall Street cheers and pushes the market higher. However, I seriously question the use of retail sales in the US as a measure of economic strength, for two principal reasons. In my opinion, retail sales that are not accompanied by a rise in industrial production are highly questionable as an indicator for the domestic economy. They are a far better indicator for the strength of the Chinese economy, because rising US retail sales are leading to a widening of the US trade deficit with China, which is increasingly supplying the US market with consumer goods. Consider the following. The US housing industry is booming. However, US production of appliances is flat to moderately down compared to a year ago. Or take the home furnishings industry, which should be a prime beneficiary of strong home-building activity. However, furniture imports into the US have jumped 71% since 1999 and now comprise between 40% and 50% of all sales. According to an economist who has studied how US industries have been affected by rising imports, half a million workers lost their jobs in the furniture industry between 1979 and 1999. This is in stark contrast to China, which has become one of the world's largest manufacturers and exporters of furniture, claiming 10% of the global market share. In the first seven months of this year, furniture exports - principally to the US - rose 35% to more than US$3 billion.
Perhaps Fed governor Ben S. Bernanke should consider this point when advocating an ultra-easy monetary policy. He recently pronounced before the National Economists' Club in Washington that:
The US government has a technology, called a printing press that allows it to produce as many US dollars as it wishes at essentially no cost. By increasing the number of US dollars in circulation, or even by credibly threatening to do so, the US government can also reduce the value of a dollar in terms of goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.
As I have just shown, the government can generate temporarily higher ''spending'' though not necessarily higher production in the US, but overseas! If we look at the increase in US retail sales over the last three years and compare it to the increase in the US trade deficit, we note that practically all additional retail sales originated from the import of additional overseas products. Therefore, Mr. Bernanke's US printing press seems to have an extremely limited effect in stimulating domestic economic activity, while being very effective in stimulating foreign direct investments and industrial production in China and, increasingly, Vietnam. I hope that the leaders of the Asian exporting countries appreciate this fact and sent Mr. Bernanke a large Christmas card - naturally, one made in China.
A similar situation to the US furniture industry is evident in its auto industry. While overall car sales are robust (although down from the torrid sales pace in July and August), sales of the three domestic producers are currently lower than they were in the 1990 recession, while sales of imported cars and light trucks are at a record. (Ford announced recently that it will boost its purchases of auto parts in China to as much as US$1 billion annually starting in mid-2003.) In fact, while the goods-producing sector lost 332,000 jobs in the last eight months, the service-producing sector has added 506,000 jobs over the same period. (Mortgage brokers were up 47,000, health services employment was up 178,000, education up 92,000, and government up 158,000.) In the meantime, the number of manufacturing jobs is back to the 1961 level.
However, rising import penetration aside, there is another reason to be skeptical about the durability of strong US consumption growth. For one thing, it should be obvious that there is at present no pent-up demand in the US, as consumers have not yet retrenched and rebuilt their liquidity, as was the case in previous recessions. In addition, until recently, US consumption was boosted above the trend-line by a decline in the savings rate. In the absence of strong stock market gains in the near future, it is likely that the savings rate will increase somewhat in the next 12 to 18 months and, therefore, contain consumption growth.
Finally, and this seems to me to be the crux of the matter, the consumer has become highly leveraged and his consumption may finally succumb to his debt load. Now, I am aware that many analysts and strategists will dismiss this concern, arguing that the consumer has been highly leveraged for a long time and has so far continued to spend and will therefore continue to spend in the future. To my mind, this line of argument is reminiscent of US strategists who, in the spring of 2000, predicted that the stock market would continue to rise, based on the fact that it had been going up for 18 years in a row. The facts are simply as follows: In 1946, as a percentage of National Income, total personal sector liabilities were 31%, non-farm mortgages 13%, and consumer credit 5%. At the end of 2001, however, total personal sector liabilities were 133% of National Income, non-farm mortgages 70%, and consumer credit 21%. Non-farm corporate liabilities stood at 44% of National Income in 1946, compared to 101% at the end of 2001, total mortgage debt was 23% compared to 93%, security credit 3% versus 10%, state and local government debt 7% versus 17%, and total credit market debt 192% versus 359%. In addition, in 1946 the personal savings rate stood at 9%, compared to around 2% now. Moreover, since the beginning of 1998, total (non-financial and financial) credit growth has surged $9.7 trillion, or 62%, to $30.4 trillion. By category, Total Household Borrowings jumped 64% to $8.2 trillion, while Total Business Borrowings increased 64% to $7.1 trillion. Since the beginning of 1998, Financial Sector Credit market borrowings have more than doubled to surpass $10 trillion. For the third quarter, Total Household debt expanded at an annual pace of 9.6%, the strongest rate of growth since the 1980s. The Household sector added debt at a record annualized rate of $724 billion. For comparison, 1998 was the first year that Households increased their debt-load by more than $400 billion. Year-to-date, Corporate sector borrowings have expanded at less than 1%, the weakest performance since 1992. These lending figures illustrate a qualitative maladjusted flow of credit. And while the corporate debt market is hardly growing at present, it required heroic 12.8% Household Mortgage Credit growth to produce GDP growth. During the third quarter, Total Mortgage Credit expanded by $235 billion - a stunning annualized pace of $941 billion (12.4%) to $8.2 trillion. This was 20% above the previous quarterly lending record set during last year's second quarter, and we are now on track for a record $826 billion of Total Mortgage lending for 2002. For the 10-year period 1988-97, Total Mortgage Credit expanded by an average $222 billion annually. The system now accomplishes as much in three months. Noteworthy is the fact that Total Mortgage Credit growth accounted for 88% of Total Non-federal Borrowings during the third quarter (versus 1990's average of 51%). This one ratio provides a striking example of a maladjusted qualitative distribution of the money stream, which usually becomes a factor of instability for the entire economy at some point.
I hope the reader will understand that the current mortgage financing boom and consumer credit explosion is simply not sustainable in the long run and that, at some point, credit expansion in the consumer and mortgage sector will slow down, as it has in the last two years in the corporate sector. The consequences of such a slowdown will obviously be that consumer spending will have to slow down very considerably, which will inevitably hurt the economy, but hopefully will redress some of the external imbalances. So, whereas economists who point out that the consumer is in great shape may be correct now, sometime in the future the consumer may wake up with a terrific ''debt hangover'', which will force him to retrench.
In this respect, some additional observations might be in order. In the third quarter of this year, household net worth fell 4.5% from the second quarter to US$38 trillion, according to the Federal Reserve. The ratio of net worth to disposable personal income sank to a seven-year low of 4.9 in the third quarter from 5.2% in the second quarter and 6.3% at the end of 1999. The drop in net worth resulted from shrinking assets and rising debt. Assets fell 3.4% to US$47 trillion (mostly stock market related), while liabilities rose to US$8.5 trillion, mostly as a result of the increase in mortgage debt described above. So, whereas in the late 1990s the equity bull market enabled households to boost spending and reduce savings, the recent bear market is leading to reduced spending and a rise in savings. It is also in this context, and in order to boost the currently under-funded pension funds, which will become a drag on future corporate earnings, that we must understand the US administration's desperate efforts to boost the stock market a tout prix - even at the expense of creating other sets of problems such as the consumer and mortgage credit bubble we described above, a weaker dollar, and higher inflation rates for commodity prices, which will in turn depress bond prices.
In recent reports I have repeatedly drawn the readers' attention to the rise in housing and commodity prices over the last 12 months. The purpose was to show that, although we are in a deflationary environment for manufactured goods, principally because of the rising supply of ''cheap'' consumer goods from China, a shift has taken place in the last two years from inflation of equities (or a bull market for equities) to inflation of hard assets such as residential real estate and commodities. But whereas it would appear that housing inflation in the UK and the US is nearing an end, commodity prices appear to have completed a multi-year base and are poised for further gains. It is worth noting that despite weak global economic conditions and weak stock markets around the world, the CRB Commodity Futures Index has risen by more than 24% over the last 12 months. Also, as I have pointed previously, commodity prices have been in a bear market for more than 20 years and, in the age of capitalism, have never been as low as just recently. Therefore, once fundamentals improve, prices could run away on the upside. However, what do we mean by ''once fundamentals improve''? For one, if synchronized growth around the world should materialize (a scenario about which we have serious reservations, but which is nevertheless a possibility for the short to medium term given central bankers' propensity to print money), then obviously the demand for all commodities should improve and drive prices higher. But more importantly, with people like Mr. Bernanke at the Fed, and actually even being a serious candidate for future chairman of the Federal Reserve Board, depreciation of the dollar and a rise in commodity prices is almost guaranteed - particularly if the economy weakens. In fact, Bernanke's statements didn't go unnoticed by the believers in sound money (gold), who subsequently pushed gold prices through an important resistance level. Therefore, if easy monetary policies bring about higher commodity prices, interest rates, which usually move inversely to commodity prices will rise and bring an end to the current unsustainable mortgage-refinancing boom. And once the consumer can no longer borrow against his house in order to sustain his spending habits, consumption and along with it the economy are likely to collapse. As a result, I would look at selling US equities during the present rallying phase, and avoid the US dollar and US treasury bonds. In my opinion, the Euro and gold will continue to outperform US equities, as they have already done so over the last 18 months.
