More On Trends And The Effect On Savings/Consumption

We all know that Treasury is printing money.
We all know that National Notional Debt levels are exploding.
We all know that the federal budget deficits are at obscene levels.
We all know what debt and or deficit financing/spending really is.

But the question is how did all of this happen?
What are the trends that made these type of deficits a reality?

Many factors, but you can blame deregulation, defense build up, and budget deficit explosion mostly starting in the early 1980's.

Its all policy and the unintended repercussions of that policy. We have had a weak dollar/import driven consumer policy that has minimized savings and maximized consumption.

Our Central Bank for the last 25 years, on the surface has never had an inflation target policy. Its all about growth and consumption. If one actually had an inflation target, you can assume that savings would be drastically higher. Now you can argue these trivial facts, but Greenspan wasn't an inflation hawk, and we definitely know that Bernanke is not. We have to go back to the Paul Volcker days to get some objective talk on the inflation front. Central Banks have a mandate to keep prices stable, this is how the Euro Zone works. Price Stability is the main mandate to any Central Bank. Our mandate has always been to keep the machine going. Growth and consumption gets you elected in this country. Greenspan doctrine was all about transparent references to fighting inflation but in the mean time keep rates low enough where growth and or consumption doesn't get damaged at the behest of savings. You cant save and grow the economy at the same time. This is what Japan has been working through for the last two decades. The Japanese central bank totally took their eye off the ball by letting speculators run up asset prices across the board, this easily could have been prevented if the BOJ had some control over interest rate policy. It is this painful lesson that we are going through in this country.

Let me explain and lay down the groundwork.

Our Central Bank only looks at potential inflation targets to see how much productivity gains are needed to offset any increase in prices on the wholesale level. If they think that inflation is 2%, its really 3% if you include asset price increases, they need roughly 3% productivity gains. This is roughly the level of productivity that a capitalist economy needs to keep the machine going. But to achieve this equilibrium, the money supply has to increase 6%.

So what we have here is roughly 6% increase in the money supply every year, how is this being absorbed into the general economy? It is being absorbed, but in the process huge deficit imbalances are created. This is what has been going on for decades.

Its these imbalances that have manifested themselves into a general lack of savings and excessive credit creation, since interest rates are to low. In this type of environment consumption growth is very strong, since again it doesn't pay to save and debt financing is very cheap. This is how asset bubbles are formed and maintained by policy.

What typically happens after wards is the start of a positive feedback mechanism (Wall Street/Media/Govt) that further inflates the bubble through housing prices, equity prices, and home equity lines of credit. Corporate profits greatly benefit from this consumption. Unemployment was kept low as businesses hired to to satisfy consumers end market demand. The resulting wage growth supported the housing market.

But it was all a facade. These imbalances will eventually lead to a blow off top. As the positive feedback mechanism creates a cultural change in consumer buying habits. People just start living outside of their means. They become unrealistic about their own lifestyles. All of these various consumer lead behaviors led to inflated premiums in asset prices that were not supported by reality. In turn the debt levels increase and the fundamental value of the assets they support are far away from historical norms.

These type of cycles take decades to form, but break down very quickly as we have seen. they break down when consumption growth takes a breather. The debt levels supporting these assets are no longer viable. It really doesn't matter how low interest rates are, if there is no demand. So what happens now is the asset bubble gets deflated, massive deleveraging takes place, all hell breaks loose, prices spiral down way past equilibrium, and guess what? The positive feedback mechanism goes negative for the following reasons:

1-Falling Profits
2-Falling Asset Prices
3-Bank Loan Losses
4-Credit Contracts
5-Consumer Spending Falls
6-Credit Delinquency
7-Liquidity Drys Up.

What needs to happen to negate these situations is time. You need ample time for deleveraging to take place. The downward spiral in housing prices will only right itself when it reaches equilibrium price. It very well may overshoot, but we are not there yet.

The biggest driver for GDP growth was housing and mortgage finance.

tradersutra.blogspot.com/2009/07/gdp-growth-expectations-are-pipe-dream.html

tradersutra.blogspot.com/2009/07/shadow-home-market-holds-key-to-housing.html

Housing is still diving in most areas of the country which means that mortgage debt will also shrink. So consumption will automatically take a dive. 70% of GDP is consumer spending. Most Americans are in debt reduction/save mode. When I say save, I mean real savings aside from stocks and mutual funds.

We need to see savings reach pre-1980 levels of 7% of GDP. This automatically means that consumer spending/consumption declines to 62%-64% of GDP. But can spending drop like this on a dime? Damn right it can...We see the early signs of it at this moment. People are shell shocked with the economy and the markets, when things get a little clearer, its not going to be all systems go.

tradersutra.blogspot.com/2009/07/consumer-halcyon-days-are-over.html

This singular upcoming consumer development will have huge implications on businesses, financial sector, and broader economy. There is going to be a smaller pie of consumption demand for businesses to compete for. Its a known stat that as savings-to-consumption ratio rises, corporate profits tend to decline as a share of GDP.

This is relevent as the Bureau of Economic Ananlysis recently showed that US Savings Rate as a % of disposible income came in at 6.9%. This is the highest since 1993. This doesnt take into account debt repayment, a huge variable that states that people just are not spending anymore.

If we do see higher savings from consumers, bet on the fact that corporate earnings are going to sink, which is the primary reason to own the stock market on any given day.