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Why There's No Case for Healthy Economic Growth


Without such growth, equity markets cannot help but languish as they have for the past 10 years -- at least until consumer balance sheets have healed.

Editor's Note: This article was written by Robert Barone, head of Ancora West. Mr. Barone currently serves on AAA's Finance and Investment Committee which oversees $5 billion of investible assets.

It took 20 years of over-consumption and living beyond their incomes for Americans to get to their current economic state; the elected officials in Washington, DC, continue to hunt for a quick fix, one that just doesn't exist. Meanwhile, the economy keeps on lurching, and, at the same time, morphing into what it will look like in its future state as we move further away from the financial crisis and deeper and deeper into a slow-growth economy. In the near to intermediate term, the economy will, I believe, display a tendency for more frequent recessions.

The Consumer's Financial Condition

The consumer is simply carrying too much debt. In the US, consumption represents 70% of GDP, but the consumers' debt/GDP ratio, which spurted from 100% in 2001 to more than 135% in 2008, still stands at 126%, nearly three years after the recession began. Much of the nine-percentage-point decline is due to financial institution write-offs as opposed to debt repayment, so it appears that the consumer has a long way to go to even get back to the 100% ratio. Short of the government waiving its wand and pronouncing that all debt is now magically repaid, the next healthy economic upswing must await the healing of household balance sheets.

Unfortunately, to get a healthy consumer balance sheet, savings must increase to repay the debt, which leaves less for consumption. Lower consumption means slower economic growth with all the attendant implications for employment. This is known in the economics profession as "the paradox of thrift." Thus, getting back to a healthy and sustainable level of economic growth in which new jobs are created and the unemployment and underemployment rate falls will take much longer than we've experienced in any of the post-WWII recessions. Unfortunately, the politicians want desperately for this to pass quickly, lest the electorate cast them out. So they promote ill-conceived schemes that wind up only prolonging the agony -- like "Cash for Clunkers" and the "homebuyer tax credit." These programs promote more debt which will have to be reduced in the future, so they simply wind up pulling demand forward at the expense of economic growth a quarter or two out, and prolonging the adjustment, as more debt now needs to be worked off.


For the next few years, until balance sheets are healed, economic growth will simply be sub-par. Below is a discussion of some of the headwinds and their consequences.
  • According to the US Chamber of Commerce and National Federation of Independent Businesses, uncertainty as to economic policies, taxes, the cost of health care, new regulations in the financial reform bill, and the ongoing credit crunch are causing businesses to hold back on hiring. But, even if this is resolved, the need to work off debt together with the loss of retirement income by the baby boomers will cause them to put off retirement for several years. This will trickle down to the younger generation who will find it increasingly difficult to find satisfactory employment. We'll see the U6 unemployment measure (which counts the underemployed) continue to maintain a much wider spread against the traditional U3 measure of unemployment that it has over the last couple of decades.

  • The purchase of big-ticket items will be significantly impacted. Houses and cars are the first items that come to mind. Expect continued downward pressure on home prices, especially high-end homes, until the debt ratios are significantly reduced. And, don't expect auto sales in the US to return to their former peaks anytime soon. It's likely that they'll continue to be below the replacement level of 12-13 million units per year required to keep the average age of the US auto stock from climbing further than it already has. Besides autos and homes, other big-ticket items will continue to be impacted. Travel and vacations will be closer to home; restaurant tickets, on average, will be lower. So will just about every other consumer discretionary purchase.

  • Financial institutions will continue to struggle. John Hussman, in his July 12 blog, observed that while financial "operating profits" appear to have recovered (leading to large management bonuses), below the surface, large write-offs and one-time charges continue. And it's quite apparent from the state of the housing industry and from the condition of consumer balance sheets that large foreclosure related write-offs will continue. Both David Rosenberg (Gluskin/Sheff) and Hussman point out that consumers continue to pay for the items that they absolutely need (their credit cards, cars, and even their HELOCs), but many have simply stopped making their mortgage payments. As a result, they have the cash to spend that they would have used to make those mortgage payments, thus giving consumption the slight lift we've seen in the last couple of quarters. Sooner or later, however, that cash will have to go to rent as their foreclosures are consummated. This will inevitably put even more downward pressure on the growth rate of consumption.
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