Warning! Facing the Recessionary Numbers Can Lead to Depression: Why Uncle Sam Needs to be Extra Generous This Holiday Season

October 17, 2001

For those of you yet unaware, the United States economy is almost certainly in recession for the first time in more than a decade.  Furthermore, this recession would have in all probability have come to pass whether the September 11 Attacks on America had occurred or not. Although the terrorist attacks appear to have turned a bad economic situation worse, the ingredients needed for further economic lethargy were thriving well before September 11.

To begin with, there are a host of reasons given for why the current economic recession could be extremely short lived, not the least of which is lower interest rates, looming economic stimulus packages, and falling energy/commodity prices.  However, these potential positives for the American economy need to be broadly recognized as positives before they can have any salutary effect. It is up to businesses and consumers to turn a favorable regulatory, and inflationary backdrop into a flowering economic environment. To be sure, lower interest rates do not increase lending if the underlying credit quality of potential borrowers is poor, and economic stimulus packages can only provide a temporary spark for growth not a complete overhaul of pre-existing weaknesses in the economy.  If the conditions for sustainable growth are not already present, it is unlikely that the fiscal spark so far proposed will develop into a blaze of economic activity.

What does ail this economy is debt. Such an obstacle cannot be negotiated through interest rate manipulation alone, and any alternative attempt to idle debt loads comes at a cost.  By 'cost' this is to say that debt write offs have a material impact on finance: this is the case when banks are forced to write off bad corporate loans, when citizens declare bankruptcy on their debts, or when companies layoff workers to increase profits to fund debt obligations.  In sum, debt is a real material force not an accounting convention.  As such it constitutes a powerful structural negative for the broader economy.

The American consumer, which accounts for two thirds of economic activity, is an especially important figure when it comes to debt.  During the late 1990s the seemingly insatiable demand of the U.S. consumer helped form a terrific period of growth the likes of which had never before been seen in the U.S.  However, much of this growth was fueled by the consumers' ability to take on more debt, and/or remain extremely confident about the future of the economy. Such is not the case today.

To begin to understand today's consumer it may be prudent to look back at the last recession in 1991.  During this recession the consumer actually contracted borrowings for a total of 18 months (1990-1993).  By contrast, total consumer credit has contracted for only 2 months during our current slump.

Consumer credit is by no means pre-ordained to drastically drop in the coming months simply because it did so during the last recession.  Nevertheless, there are other debt-related statistics which do not bode well for a sustained recovery in the near future.  In particular, the household debt service burden is near an all-time high. What this percentage tracks is the total debt load the consumer has versus disposable income. Not surprisingly, this number also dropped precipitously back in the early 1990s.  In fact, if the ratio were to contract back to 11.84%, or the 1993 low, this would equate to nearly $200 billion in displaced monies, that is, money spent to pay down debt rather than on consumer items.  Given that this amount is more than double the proposed size of the Republican stimulus package, any increase in domestic consumption could be minor indeed.

As should be clear by now, recession brings about ominous patterns in consumer spending.  As such, this is not the time for the governing bodies to be diplomatic in their discussions of spending, and debt.  Rather, they need to attack the loss in consumer confidence, and dispel any notions of prolonged economic recession.  If the Keynesian route is the path that this government wants to travel, than it had better do so whole-heartedly.  Halfway measures will end up being absorbed in debt repayment rather than stimulating an economic turn-around.

Lastly, the 'investing' consumer has watched the U.S. stock markets' capitalization drop nearly $6 trillion in value during the current slump. For a nation of mutual fund lovers this total serves as a reminder that fortunes may not be made through investment, and stock options alone.  Moreover, in an environment characterized by increasing layoffs, and given that savings rates are near all time lows, it is to this same depressed equity market that many 'investing' consumers must turn to in order to provide the liquidity necessary for consumption and debt repayment.  Of course this has the potential to drive stock prices lower as sellers outnumber buyers, propelling consumer confidence down along with it.

As if consumers were not faced with enough challenges, we have the deteriorating corporate environment.  Corporate America funded much of its expansion in the 1990s by increasing debt loads.  These debt loads were rarely regarded as a negative when stock prices were dramatically rising and the consumer was forever spending.  Now that this exciting growth period has calmed, a similar set of challenges to that of the U.S. consumer faces American businesses.

Just as the consumer may spend less to shore up their financial positions, so too may businesses continue to cut excesses until demand picks up. Suffice it to say, drops in capacity are not resolved by corporate faith in the future, rather a tangible pick up in demand.  As such, it is a forgone conclusion that layoffs will continue to mount, and capital spending will continue to stagnate so long as near term consumer demand is uncertain, and/or falling.

In sum, there are only two possible resolutions to the current economic malaise: either the consumer starts spending or the government does.  The economy is faced with the beginnings of an economic recession in an environment where the consumer appears unprepared to spend.  On the plus side, mortgage refinancing, relatively low unemployment, and tax breaks could alleviate some of the pressure. But the negatives are ever apparent: how do you teach a consumer that is thinking recession to spend beyond their means?

Small amounts of natural gold were found in Spanish caves used by the Paleolithic Man about 40,000 B.C.