Mr Economy had long been gravely ill, sick unto death some said. He had endured emergency surgeries, including a dangerously botched removal of his Lehman. He had received massive doses of stimulus, but still his unemployment temperature spiked to 10.2%. His relations were frantic, his physicians perplexed. All agreed that only one doctor had the cure for what ailed poor Mr Economy, but would she come in time? And so, with the holiday season fast approaching, the cry goes out: “Where, O where is Dr American Shopper?”
Unfortunately, Dr Shopper isn’t in such great shape herself. No less an authority than the legendary investor George Soros recently proclaimed, “The American consumer will no longer be able to serve as the motor for the world economy.” Before considering what prompted Mr Soros’ prediction, it’s useful to clarify an important point about modern consumer societies. In the developed world, almost no one makes what he or she eats, drinks, wears or shelters in. Our dependence on organized commercial and social networks for every necessity is nearly total. But spending for the necessities is nowhere near enough to keep the economy healthy. That requires spending enormous amounts on goods and services we want or like but that, in no sense of the word, do we need. Consequently, when times get tough, it’s not a great hardship—at least initially—to cut back, even for those who don’t have to.
This brings us to Dr Shopper’s first problem, a lack of confidence about the future. Two separate and highly regarded surveys of consumer sentiment are conducted monthly by the University of Michigan and the Conference Board. While merely opinion polls, decades of research have clearly demonstrated their correlation to actual future consumer behavior and, by extension, to the economy itself. This month, following a mid-year rebound, the surveys unexpectedly revealed falling confidence in both present and future economic conditions. To quote from the Conference Board summary:
“Consumers' assessment of present-day conditions has grown less favorable, with labor market conditions playing a major role in this grimmer assessment. In fact, the Present Situation Index is now at its lowest reading in 26 years. The short-term outlook has also grown more negative, as a greater proportion of consumers anticipate business and labor market conditions will worsen in the months ahead. Consumers also remain quite pessimistic about their future earnings, a sentiment that will likely constrain spending during the holidays.”
Despite the present high unemployment rate, more than 138 million Americans have jobs, compared to an average of 119 million during the long expansion between the 1991 and 2001 recessions. The odds are that Dr Shopper has a job; the point is, she’s worried about keeping it, and her worry drives her spending decisions. Of course, Dr Shopper doesn’t actually spend money she has in her pocket. Rather, she borrows the money to spend. She has been borrowing a lot less recently. In September, the most recent month for which data is available, the amount of consumer credit declined by $14.8 billion. It was the twelfth drop in the last 14 months and the eighth in a row, the longest streak since the Federal Reserve began keeping track in 1943. Since peaking at $2.581 trillion in July 2008, the amount of non-mortgage consumer debt outstanding has fallen to $2.455 trillion. Eighty-six billion dollars of that $126 billion drop is in revolving debt, that is, credit cards. More confident consumers would have spent that money.
While credit card debt is falling, credit card costs are rising. Bloomberg News reported that the average credit card rate is up to 12.64% from 11.84% in January. Credit card issuers are raising rates and fees, while eliminating specials to get out in front of the Credit Card Accountability, Responsibility, and Disclosure Act, which takes effect in February. New fees and higher rates are also needed to make up for greater losses. Delinquency rates at the major companies are roughly double their recent lows, even at American Express, with its more affluent customer base. According to Citigroup, worse is yet to come, with credit card charge offs expected to peak at 12% by next spring.
A second former source of consumer debt has dried up as well. The Joint Center for Housing Studies of Harvard University reported that home equity fell by $2.5 trillion in 2008 and by nearly $5.9 trillion since 2005. The result, as the chart to the left shows, was that homeowners took 200 billion less dollars out of their homes in 2008 than in 2006. Undoubtedly, cash-out refinancing will fall further this year. People who drained their homes of equity during the bubble period may not have realized it, but they were simply monetizing their gains, in the same way shareholders stock when the price rises. Now, that home prices have fallen 28% on average, those gains have evaporated, for both those who cashed out and those who didn’t.
The decline in home values is an obvious cause for the drop off in cash-out refinancing, but it’s not the only one. Many refinanced mortgages wound up in private, non-government guaranteed loan securitizations, which were a casualty of the financial explosion of 2007, as well they should have been. Private mortgage securitization was catalytic in creating the excesses of the housing bubble. Mortgage bankers outdid themselves in dreaming up variant structures because anything and everything could be securitized. But now, originators can sell almost nothing but plain vanilla 15- and 30-year fully amortizing fixed rated mortgages. Discover Card CEO was quoted last spring as saying, “I view it as rolling back the clock. Some of the innovations that have taken place in our business over the last 15 years will be rolled back.” That’s true in spades with mortgages. While the death of pay-option ARMs, interest-only mortgages, zero-down payments loans, and frequent refinancing is generally a good thing, it’s not an entirely good thing. The stifling of innovation will protect many consumers, but, by enforcing thrift and prudence, it also dampens consumer spending.
The combined impact of these various forces is apparent in the broadest measure of retail sales. The Census Bureau’s monthly report shows that the total dollar volume of sales has fallen all the way back to the levels of 2005. Monthly sales were between $370 billion and $380 billion from mid-2007 to mid-2008. This year, they have averaged $342 billion, a decline of nearly 9%.
Yet, there are beginning to be signs of resurgence. The Wall Street Journal reported that retail sales increased during Octobers at both low-end discounters and high-end retailers. TJX’s Marshall’s and TJ Maxx stores reported sales growth of 10% over September, while Nordstrom was up 6.5%.
The graph below is helpful in understanding these changes, though it is a bit complicated. It shows weekly percentage changes in same-store sales in large US general retailers open for a year or more. The changes are measured against sales a year earlier. The period covered begins with the week of November 13, 2007, and continues through the week ending November 3, 2009. Compiled by Redbook Research Inc, the sample represents about 9,000 stores. As you will see, sales comparisons turned negative about a year ago, rebounded in April and May 2009, before collapsing again in the summer. The trend finally turned positive in mid-October, and retailers are expressing optimism that it will continue.
Economists like to use the metaphor “headwinds” to describe factors inhibiting growth. A real headwind opposes the course of a large and powerful moving object, like an airplane. Mr Soros’ opinion notwithstanding, there are few more powerful moving objects than the American consumer. Shopping, after all, is our national sport. It’s what we do. It’s what we ARE. And we are starting to go back to the mall. Dr Shopper is on her way. She may be slow in coming, but when she arrives, her healing touch will surely pull old Mr Economy through.