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Sunday, July 17, 2011

Leonhardt: "We're Spent"

by Calculated Risk on 7/17/2011 08:47:00 AM

From David Leonhardt at the NY Times: How the Bursting of the Consumer Bubble Continues to Hold the Economy Back (ht Ann)

THERE is no shortage of explanations for the economy’s maddening inability to leave behind the Great Recession and start adding large numbers of jobs ... the real culprit — or at least the main one — has been hiding in plain sight. We are living through a tremendous bust. It isn’t simply a housing bust. It’s a fizzling of the great consumer bubble ...

The auto industry is on pace to sell 28 percent fewer new vehicles this year than it did 10 years ago — and 10 years ago was 2001, when the country was in recession. Sales of ovens and stoves are on pace to be at their lowest level since 1992. Home sales over the past year have fallen back to their lowest point since the crisis began. And big-ticket items are hardly the only problem.

The Federal Reserve Bank of New York recently published a jarring report on what it calls discretionary service spending, a category that excludes housing, food and health care and includes restaurant meals, entertainment, education and even insurance. Going back decades, such spending had never fallen more than 3 percent per capita in a recession. In this slump, it is down almost 7 percent, and still has not really begun to recover.
Business executives are only rational to hold back on hiring if they do not know when their customers will fully return. Consumers, for their part, are coping with a sharp loss of wealth and an uncertain future
Here is the NY Fed paper by Jonathan McCarthy that Leonhardt mentions: Discretionary Services Expenditures in This Business Cycle
The pronounced weakness in personal consumption expenditures (PCE) for services has been an unusual feature of the 2007-09 recession and the slow recovery from it. Even in 2010:Q4, when real PCE increased at a relatively robust 4.1 percent annual rate, real PCE on services rose at only a 1.4 percent rate. This weakness has been especially evident in “discretionary” services (to be defined below), which fell more in the recent recession than in previous recessions and since have rebounded more sluggishly. In this post, I suggest that the continued sluggishness in these expenditures lends a note of caution regarding the sustainability of recent PCE strength. ... this in turn raises some concern about the future strength of the recovery.

The chart below shows how much real per capita (to account for differing rates of population growth over time) discretionary services expenditures fell from their previous peak—a zero value in this chart means that these expenditures were above their previous peak. The drop in discretionary services expenditures in the last recession was much more severe than in previous recessions ...
Discretionary Spending Click on graph for larger image in graph gallery.
Because many of these expenditures can be deferred when economic conditions are strained (for example, eating at home rather than eating out, or passing on the visit to Disney World) and given the increasing share of services in the economy, discretionary services will remain a significant factor in business cycles. In the recent recession, the large rise in unemployment and the sharp drop in household wealth appear to have led households to reduce discretionary services expenditures to a greater extent than we have seen previously, as they attempted to maintain a smoother path of non-discretionary services expenditures.

... the fact that discretionary services expenditures remain significantly below their previous peaks is of concern for the overall economic outlook. Although these expenditures can be deferred in instances of temporary income drops, the sluggish recovery in these expenditures suggests, consistent with the permanent income/life cycle hypothesis, that households may perceive more persistent shocks to their overall wealth. ... Accordingly, the continued sluggishness of discretionary service expenditures at this point in the expansion lends a note of caution regarding the recently improved economic growth outlook.
This is one of the reasons I track some items of discretionary spending like hotels and restaurants.

To take this a step further - with the lack of demand, there is still too much excess capacity in most areas of the economy for a large contribution from new investment (except in equipment and software). We see this excess in housing (there is an excess supply of vacant housing units), and excess capacity in overall industrial production. There is also excess existing supply in office space, retail space, and other categories of commercial real estate.

In addition, household debt, as a percent of income, remains very high and household deleveraging is ongoing. That is why so many companies identify their number one problem as "lack of customers" (see the small business survey released this week).

Until the excess capacity (and excess supply) is absorbed, and household balance sheets are back in order, the recovery will remain sluggish.