Thursday, 30 September 2010

Economic future

I was asked my thoughts on this article by Neville Bennett which is his thoughts an the near economic future.
Governments will wrestle with mounting debt-servicing costs and be forced to make severe budget cuts, especially in welfare and education. High structural unemployment will endure in the West and will fall heavily on youth, the unskilled and even mature workers.

High unemployment, higher taxes, foreclosures, and very tight credit will encourage a new frugality to consumers.

The share of consumption in GDP will decline. Savings should increase but savers will find yields low, especially in the deflation prone Japan and the USA.
Bennett goes on to describe the recovery as "L" shaped, which is not a description of the shape of the graph, but shorthand for long. I agree with his assessment, though it is not clear whether he thinks we still on a downward trajectory, or are near the bottom but will be a long time rising? I suspect the former and I concur, we still have a long way to fall.

Interestingly he describes shocking behaviour of consumers, partly due to excessive credit,
More accurately, personal liabilities in 2008 [in the US] exceeded 130% of personal income.

New Zealand was worse: Household debt increased six times in dollar terms between 1990 and 2008 to a massive 160% of disposable income.

Debt servicing took 15% of disposable income. The magnitude of debt provoked few concerns until about 2008.

Banks were anxious to provide 100% mortgages, and consumers often enjoyed the “wealth effect” of rising home values and stock investments.

Consumers used their homes like an ATM: taking loans for home improvements, cars, furnishings and even holidays.

Personal savings virtually disappeared. They were about 10% of income in the 1970’s but by 2008, Kiwis spent $1.13 for every dollar earned. Americans behaved similarly.
Overall I think the article reasonable. It appears to specify what he thinks will happen, not what he thinks should. Comments on actions governments and individuals should take would improve the article.

He is likely correct about unemployment rising, and being worse for the unskilled who are frequently the youth, this will be exacerbated by the high minimum wage.

There are some areas where I disagree, or at least would clarify his comments.

I am not certain his reasoning for the rapid rise out of recession in the 1980s is correct.
The US could roar out of some recessions, like that of 1981-2, because the baby-boomers were young (many in their 20’s) and high earners with heavy spending on homes, furnishing and cars.

Consumer spending rose 7.2% in 1982. The demographics are different now with many people scrimping in retirement. Personal debt is US$124,000 per household and that takes a lot of paying off, especially as house values have plunged and stock markets been volatile.
There may be some truth to this, but one has to wonder how accurate the data is over the last 30 years. Not to mention the theory that the bursting stock market bubble was offset by the technology bubble, which was offset by the property bubble, which is the last reasonable bubble. Thus the current doesn't lack solutions, rather the compounding of the recessions of the last few decades. There may have been no true recovery, debt funded spending just hid the true situation.

Bennett mentions tax increases leading to frugality,
High unemployment, higher taxes, foreclosures, and very tight credit will encourage a new frugality to consumers.
It is not clear whether he predicts this or advocates this. I am not too certain that these things will effect a change in behaviour, profligacy being a moral problem. But higher taxes should be avoided; they will do little to address the spendthrift problem but will prolong recovery and exacerbate unemployment. Tax cuts with even greater reduction in government spending would be far better long term for employment the economy.

A minor quibble, he talks about bi-inflation
Bi-inflation. Rising prices for commodities and gold, deflation in much of the economy.
So he is using the term inflation to describe prices, whereas it strictly means monetary supply. Will the monetary supply increase (inflation) or decrease (deflation). Price changes are reflective of the amount of money in circulation all other things being equal (which they may not be). It appears that Bennett thinks there will be deflation of the monetary supply with the prices of most things decreasing but some exceptions. I think the government will try and inflate, the question is will they be able to? I hope there is deflation. Prices will go generally go down as will incomes, but not debts! Some prices may rise because of decreased or unchanged supply combined with increased demand.

Worth a read, food for thought.

2 comments:

  1. America isn't going to roar out of the recession, because the whole presumption is that there are high earners with heavy spending on homes, furnishing and cars.

    Well to have high earners you need well paid jobs, not just a few but a lot. Where are they?

    Heavy spending? Aside from gaming models I try not to spend money on more than getting to work, getting to see my fiancée, food, clothing and shelter. In turn as little as I can and I can't see anyone else doing differently.

    There are people who have money, but they aren't spending, those who have debts are trying to pay them down, often with woefully inadequate incomes.

    In short, the economy is like faeries in Peter Pan. Believe in them, clap hard enough, and they live. Nobody is clapping any more.

    ReplyDelete
  2. Duke, The way out is debt reduction. The question is whether governments will prolong the agony by increasing debt first.

    Biblical principles of productive work, saving, and thrift are economically beneficial, and allows for more capital to create efficiencies. Steady growth without the bubbles, which means those who make money in a bubble expansion and cash in before the bust, but don't produce anything, would be forced to do legitimate work.

    ReplyDelete

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