Sunday, January 25, 2009

Home Economics

Amid the seeming endless string of articles bemoaning the perilous state of the economy, the housing crisis, the credit crunch, and the recession, one expression we often encounter is “consumer confidence.” And it's an important concept, no doubt, considering that 70% of the American economy is fueled by domestic spending. But it strikes me that the underlying message that often accompanies this phrase--that low consumer confidence is intrinsically dangerous to the economic recovery--is wrong-headed. It is too seldom pointed out in such articles that low consumer confidence is directly correlated to the fact that people don’t have any money.

Consider the following passage from an article in the business journal Bloomberg:

Consumer confidence sank to the lowest level in at least 41 years this month as Americans grew more concerned about keeping their jobs and paying their mortgages, raising the risk they’ll spend less next year.

I find this phraseology very interesting. It associates risk, not with losing jobs or defaulting on mortgages, but on spending less. We are being led to believe that Americans are foolish when they become concerned about keeping their jobs and making their mortgage payments. Can’t they see how risky it is (to the economy) to spend less than they spent last year?? As we read on the same fractured logic becomes more pronounced.

Economists had been counting on a plunge in gasoline prices to improve consumers’ moods. The decline in confidence signals that spending will tumble further next year and prolong the recession after a holiday shopping season that may have been the worst in at least four decades. “The deterioration going on right now in the labor market made people feel much worse,” said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts. “If people are worried about their jobs, they are not going to spend. That is extremely negative.”

But we have recently been shown the effect of a business climate in which people spend money they don't have, and few would dispute that the it has also been extremely negative. Can it be that the recession, the stock market crash, the escalating costs of health care, and all the rest, are simply a matter of mood. Everyone is in a bad mood, and people feel much worse. What is this, junior high?
A little further on we get some real numbers, and they tell a more accurate story.

The average price of a gallon of regular gasoline dropped to $1.62 on Dec. 28, down 61 percent from July’s record... That wasn’t enough to overcome the damage from the loss of 1.9 million jobs and a slump in household wealth after the collapse of home and stock prices.

In short, it isn’t merely that a “deterioration in the labor market” that makes people feel bad. It’s the fact that they have lost their jobs, or are fearful of losing them. And the truth is that people who don’t have secure jobs (or any jobs) not only feel bad, they spend less, because they don’t have much money. That may be “very negative,” as the chief US economist suggests, but it is also very wise.
In the end “consumer confidence” is a psychological rather than an economic concept, and the world would be a better place, I think, if we added another concept alongside of it. Perhaps we could call it the “delusion index.” After all, just as market researchers can tell us how likely people are to be spending money any time soon, so genuine economists can tell us how much money people actually have to spend at any given time.
I am not an economist, but I’m sure there is some sort of debt/equity ratio that would be to the point here. The federal reserve keeps track of a DSR (debt service ratio) which is an estimate of the ratio of debt payments to disposable personal income, and an FOR (financial services ratio) which adds automobile lease payments, rental payments on tenant-occupied property, homeowners' insurance, and property tax payments into the mix. During the early 1980s the DSR roamed the 10-11 point range. In recent years it has been consistently above 14. During the same period the FOR has risen from 13 to 17 and higher.
In short, people have more debt these days, relative to their disposable income.

THE UNFOLDING STORY takes us all the way back to the early 1980s, when the household debt market was deregulated. Since that time, many Americans have consistently spent a little more than they make by drawing equity from their homes, the market value of which was also, until recently, increasing at a very healthy rate. The math was fairly sound, and the purposes to which that expanded pool of funds were put--bigger TVs, college tuition, ATVs, restaurant meals, lakeside homes--were not entirely outlandish. The rise in stock market values also fueled the conficence with which we all kept one another employed and feeling flush.

At a certain point this house of cards inevitably came tumbling down, as buyers stopped buying and even defaulted on home loans, leaving speculators, mortgage companies, and contractors in the lurch and deflating the price of homes at a rapid rate. Under the circumstances, it would be silly to say that consumers had merely lost their confidence, as if it were a psychological problem. Rather, the weight of debt and the evaporation of ever-new sources of credit have driven people to stop buying things. The delusion index—the gap between income and purchases, has reached a point where it can not be sustained by even the most “creative” leveraging of equity.

I would like to see some adventurous economist develop and sustain such a statistical tool--the delusion index. I think it would show that we are not as bad-off as the newspapers would lead us to believe. And it would also provide a useful corrective during those times when it seemed we could buy anything, pay for it later--and make some sort of profit besides.

If such an index already exists, it's a wonder no one refers to it in print. Or perhaps I'm simply reading ther wrong newspapers.

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