Stephen King: America's consumer boom could yet end in tears

Corporate cost-cutting can hardly be good news for employees and, hence, consumers
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The Independent Online

"Spend, spend, spend!" Viv Nicholson's famous boast is, perhaps, an inadvisable recommendation for pools winners – or for those hitting the National Lottery jackpot – but, apparently, a perfectly reasonable goal for the typical US consumer. According to consensus thinking, so long as the US consumer keeps dipping into his or her pockets, there is little reason to believe the US economy will enter the rocky waters of recession.

The latest revisions to the second quarter GDP numbers certainly provide some support for this view: the US economy managed to grow at an annualised 0.2 per cent based entirely on a 2.5 per cent annualised increase in consumer spending. Without this support from consumers, the US economy would already have entered the recessionary mire.

How safe, however, is the assumption that consumers will continue to bail out the US economy? Consider some facts.

First, although consumer spending growth remains positive, the pace of growth has slowed dramatically: at their peak, consumers were increasing spending at an annualised rate of about 6 per cent, a far cry from the latest, much softer, numbers (see left-hand chart).

Second, although many had hoped for an early recovery in consumer confidence, there are now renewed signs of weakness. The latest figures, for August, showed a further decline in consumer confidence (against expectations of a rise). Admittedly, consumer confidence has not crashed to the levels seen during previous recessions. However, there are no indications of a recovery back to the heady levels seen during the course of the boom (again, see left-hand chart).

Third, there is plenty of evidence to suggest that consumer spending is a lagging, rather than leading, indicator of the economic well-being of the US economy. A typical US downswing begins not with the consumer sector but with the corporate sector. In the run-up to a recession, profits come under heavy downward pressure. The recession is typically caused by corporate attempts to cut costs in order to rebuild profits. Cost cutting may reward shareholders but it can hardly be seen as good news for employees and, hence, consumers.

Virtually all US recessions (associated with at least two consecutive quarters of economic contraction) have followed the same pattern. Profits collapse, often because companies are initially too optimistic about the future growth potential of the economy. In response to the profits collapse, companies shed labour. The profits collapse typically occurs before the recession gets going. The increases in unemployment typically occur at the same time – and, sometimes, slightly after – the economy begins to contract. Meanwhile, consumer confidence holds up only while the labour market remains healthy. Once unemployment starts to shoot up, consumer confidence starts to fall relatively quickly (see right-hand chart).

To suggest, therefore, that the US economy will avoid recession simply because consumer confidence remains at relatively buoyant levels is no more than a confidence trick. Consumers typically carry on spending so long as they feel secure about their jobs. Remove that security and, all of a sudden, what started off as a profits recession becomes a recession for the economy as a whole.

Are there any ways out of this recessionary maze? There are some, but either they are not particularly plausible or, alternatively, they are not particularly palatable. Among the implausible options is the possibility that consumers dip further and further into their savings, even if they are losing their jobs.

The problem with this path is it keeps America's balance of payments in sizeable deficit and, therefore, maintains America's heavy dependency on capital inflows from abroad. That's fine so long as the inflows ultimately generate a decent return for foreign investors. It is difficult, however, to see why the world's investors should be happy to fund a US consumer boom. This scenario, therefore, leaves the dollar vulnerable to a substantial collapse, another source of instability both for the US and global economies.

Another implausible option is to ensure large wage increases. This was the model last seen in the late 1960s. It was associated with a rapid collapse in the profit share within GDP and, ultimately, gave rise to the inflationary problems of the early 1970s. It was also a time of very poor performance for America's stock market. A redistribution of the national cake away from low spending companies towards higher spending consumers might ensure a faster growth rate in the short term. However, it would ultimately be a low-profit, low-return recovery which would threaten higher inflation over the medium term.

It is difficult to see how this kind of consumer action would save the day for the US economy. It is even more difficult to see companies acquiescing to this kind of "worker pressure". After all, US companies have proved themselves to be better than most at keeping their costs under control.

A final, unpalatable, option is to spread the recessionary message more thinly across the whole world in the hope that the pain for any one country will be that much smaller. Arguably, this process has already begun. Gateway is but the latest example of a US company which is seeking to reduce its costs by downsizing not just in America but also in other parts of the world. At the microeconomic level, this kind of policy may well make sense. However, at the macro level, these actions may simply be a way of speeding up the transmission mechanism of recessionary impulses from one country through to another.

In the old days, of course, recessionary pressures in one country fed through to other countries primarily through trade effects. In the modern world, however, there are many more feed-through mechanisms. Equity markets are very highly correlated. Capital flows dominate trade flows. Companies own, or control, factors of production in many different countries at the same time. As a result, recessionary pressures in any one country may now have the capacity to translate through to the rest of the world more quickly. In turn, this may imply bigger downward multiplier effects on a global scale.

There is certainly evidence to back up this view. Although none of the G7 countries is that weak relative to its own history, the collective picture is very disheartening: industrial production in the G7 is now falling more quickly than in either the recession of the early 1990s or in the 1982 recession. GDP growth in the US, Japan and Germany is now in its weakest position since the 1982 recession. In terms of global growth, a key distinguishing feature of the latest period of weakness has been the poor performance of some of the Asian countries which, in the early 1990s, were easily able to shrug off the impact of US recession. Finally, one of the key reasons why the US economy itself has slowed over the last year or so has been the weakness of exports: by spreading recessionary risk elsewhere, the US may simply have shifted the source of its slowdown away from the consumer towards exports.

In other words, the defining characteristic of the latest period of global economic weakness has been the speed with which problems have spread from one country through to another. This may have delayed the impact of the US corporate downturn on the US consumer. But it does not mean that the effect is going to be forever absent. Given this, the Viv Nicholson approach to policy making may ultimately end in tears.

 

Stephen King is managing director of economics at HSBC.

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