The Bennett Newsletter
What is the “new normal”? The concept is still in its formative stage, and its meaning embraces new trends in society and the economy. Essentially the current contraction is seen as a “game changer’ for consumers. High unemployment rates, foreclosures and tight credit markets have combined to bring a permanent new frugality to consumer behaviour that will linger for years in a "New Normal" economy with a reduced emphasis on the consumer. Moreover, savers and investors will have to adjust to very low returns unless they take more risk by investing in emerging markets.
Reaction to excess consumption
A glance at the chart will indicate that consumption in the US has risen steeply to around 70% of GDP. This is historically abnormal, and driven by credit expansion (more later). It is also anomalous in comparisons with other countries where consumption share of GDP is 64% in the UK, 56% in Germany, 55% in Canada, 36% in China and about 60% in New Zealand.
New Zealand will be greatly affected by the new normal: household debt will decrease, personal savings will lift, and consumption’s shares of GDP will decrease. The effects of this transition will shuffle though the economy, notably by reducing the bloated retail sector, and encouraging a greater export focus. As consumption in the developed world declines, counties like China and South Korea which have relied on export-led growth will have to increase domestic consumption.
The magnitude of the change is uncertain. But a correction is necessary as debt-fuelled consumption ran amok in NZ, the USA and elsewhere where shop-till-you-drop was present. In the US consumption was about 62% GDP until the mid-80’s when it started to escalate to 70%.
Household debt increased even faster. US household debt was around 60% of GDP in the 1970’s but then it took off to 102% in 2008. More accurately, personal liabilities in 2008 exceeded 130% of personal income. New Zealand was worse: Household debt increased six times in dollar terms between 1990 and 2008 to a massive 160% of disposable income. Debt servicing took 15% of disposable income.
The magnitude of debt provoked few concerns until about 2008. Banks were anxious to provide 100% mortgages, and consumers often enjoyed the “wealth effect” of rising home values and stock investments. Consumers used their homes like an ATM: taking loans for home improvements, cars, furnishings and even holidays.
Personal savings virtually disappeared. They were about 10% of income in the 1970’s but by 2008, Kiwis spent $1.13 for every dollar earned. Americans behaved similarly. What now?
New Frugality.
Wall Street worries when consumption has minor declines rather than accept the truth: consumers have changed behaviour. They are spending less, looking for bargains and cutting down on discretionary expenditure, especially on things like petrol, meals out, and various treats. Only lipstick seems immune. I have noticed that a small food mall a year ago which was crowded at lunch time is struggling. Office workers take a cut lunch and drink the firms’ instant coffee. I suspect cars will be kept longer too.
And while people in work are cutting down, life is tough for the unemployed, beneficiary and student. As some of their fixed costs are rising they have to be even more frugal. The pressure on charities is intense, and demand for community housing is growing as rents are not abating. There are many riots in the US where as many as 60,000 queue for a handful of rent vouchers. More than 30 million people are on food stamps. The growing fiscal difficulties and rate-payer vigilance is reducing amenities just when demand is rising.
Polls indicate 70 % of Americans are economising. This is slowing down American recovery. The US could roar out of some recessions, like that of 1981-2, because the baby-boomers were young (many in their 20’s) and high earners with heavy spending on homes, furnishing and cars. Consumer spending rose 7.2% in 1982. The demographics are different now with many people scrimping in retirement. Personal debt is US$124,000 per household and that takes a lot of paying off, especially as house values have plunged and stock markets been volatile.
But increased savings will not be enough to counterbalance the splurge by the US govt on its budget. Even if the budget deficit is merely 5%, and savings leap to 3%, the US will still be too dependent on foreign capital.
Finance
Mohamed El-Erian of Pimco often writes about the new normal. He believes that mounting deficits and tighter regulation will dampen growth in the US and Europe for five years, while Brazil and China with stable manageable debt and rising middle classes will thrive. Returns in the developed world will be anaemic.
This view has driven Pimco into equities, aggressive alternative investments and 10 Exchange Traded Funds (EFT). Many analysts are unimpressed: Bloomberg found that over 2000 forecasters believe the S&P500 will jump by 25% in the next year because profits are strong. But Pimco thinks bonds are over-priced and their 30-year rally has ended. States will issue massive amounts of debt and encourage inflation. Shares will rise for the next 10-20 years and offer better returns than bonds.
My “new normal” -
• Structural change in the West: less spending on consumer goods. This will compress retailing, and contribute to greater emphasis on export-led growth.
• Emerging markets find western consumers less obliging, more effort in supplying their own middle classes
• Structural change: high unemployment endemic in the West except for successful exporters like Germany and Australia.
• Structural change: tight credit in the West limits consumption and investment.
Low economic growth in the West, partly because of:
• High Western debt leads to fiscal austerity.
• Fiscal austerity has severe consequences for much of the population in reduced entitlements and services. Negative feedback loop on employment
• Funding Western debt crowds out investment.
• Household saving in West moves from negative to positive, but net yield very low.
• Cultural acceptance of frugality and thrift
• Endemic youth employment
• Ethnic tensions.
• Growing popular resentment of austerity, sometimes expressed in riots and disorder.
• Growing trade union influence? Possibly greater appeal of collectivist and socialist solutions. Confrontation right wing and collectivists.
• Criticism of globalization, calls for protectionism.
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