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American Consumer in Deep Freeze?, Part 2


Unprecedented decline in spending seems well underway.

Editor's Note: This is part 2 of a 2-part series. Part 1 can be found here.

Let's take a look at the update that James Kennedy posted last week: The actual numbers for new MEWs through the second quarter of this year show that they're are simply withering on the vine. The engine of our GDP growth has essentially been turned off.

Click to enlarge.

In 2005, there were almost $595 billion in mortgage extractions, which then went into consumer spending. (Remember, according to the graph above, that translated into a 3% rise in GDP.) In 2007, MEWs were down to $470 billion, for a GDP boost of 2%.

2008's second quarter saw an anemic $9.5 billion. At that run rate, we could see a drop-off of over 90% from 2005.

While credit-card growth has indeed risen to take up some of the slack, it's nowhere near MEWs' previous levels. With almost 20% of American mortgages "underwater," and with lending standards tightening, it will be a long time before we see a significant upsurge in home equity withdrawals.

Whatever growth we see in the next few years will have to come from old-fashioned sources, like real productivity and reality-based lending. Homeowner hallucinations are a thing of the past. And for those of you who like to digest your numbers visually, here's the chart of the decrease in MEWs.

Click to enlarge.

It's likely that whatever recovery we see will be slow in coming. Without MEWs, the period from 2001 to 2007 would have seen GDP growth of less than 1%. It's going to be a rather serious recession, and a slow muddle-through recovery lasting several years.

Last year, I predicted we would see 3 things resulting from the bursting of the housing and credit crisis bubbles:

1. We're in a period where earning disappointments are going to be the rule, not the exception.

2. Lower corporate profits will put pressure on the stock market,

3. Resulting in lower than expected long-term returns.

Let me add a fourth: The psyche of the American consumer has been seared, perhaps permanently.

The Paradox of Thrift

We're (finally!) going to see US consumers start to increase their savings. Increasing home and stock prices made many consumers feel their retirement future was assured. Now that feeling has been crushed. Home values are unlikely to bounce back for a very long time.

While it's a good thing for individuals to save money, it's not good for the economy as a whole - at least in terms of consumer spending and GDP growth. This is the Paradox of Thrift.
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