Andy Sutton's Extemporania

This week’s surprise Consumer Confidence report gives us yet another reason to take a step back and survey the landscape. Much of the recent focus has deservedly been on unemployment while little focus has been given to other aspects of the consumer and more importantly, the overall state of the consumer’s mind. Clearly there are several enigmas manifesting themselves in both confidence and spending patterns. This week we’ll take a closer look at some of these issues, and probably generate quite a bit of debate as well.

Desensitization

Increases in consumer confidence during the past two months are indicative of desensitization. Consumers are becoming acclimated to weak economic conditions, poor stock market returns, and the continued accumulation of job losses. This desensitization has been emphasized by the mainstream media; particularly in the past few months. The take-home message of articles and news reports has shifted to ‘be happy things aren’t getting worse’ and people are doing just that. Bargain hunters have been lured into many areas including housing, stocks, and even retail products. Meanwhile, important fundamentals like GDP, unemployment, foreclosures, and household net worth go largely unmentioned and underanalyzed.

Where are Consumers Spending Their Money?

What is telling, however, are the reports coming out of some individual sectors in the consumer landscape. Traditional economics breaks goods and services down into two major categories: staples and discretionary. This division follows the old-school definition of needs vs. wants. However, today, the lines have been blurred quite a bit and goods that would have easily been considered discretionary even 10 years ago are now regarded as staples.

The following NAICS category charts were selected because they represent areas that are extreme examples in the staple—discretionary continuum. And for comparative purposes, the total US Retail Sales chart is included at the end of the series.

The situation with grocery stores is a primary example of how aggregate consumption numbers are reported, which will be explained in greater detail later in the article. Just reading the chart, Americans spent less at grocery stores from the middle of 2008 through the beginning of 2009, which is when we called the bottom in terms of consumer prices. Did people eat less or just spend less on what they purchased? In all likelihood it is the latter, given that grocery store shopping is one of the most basic of spending types. For the sake of thoroughness, included below is the same chart for big-box/warehouse type stores just in case everyone abandoned their local grocery store for lower prices at BJ’s and Sam’s Club.

You’ll notice quickly that the rate of growth in warehouse club spending has been declining steadily since the beginning of the decade. Spending has also flattened considerably in the past 6 months. Clearly Americans didn’t take their unspent grocery store dollars and run to the warehouse clubs, so our initial conclusion is intact.

Gasoline station spending fell off a cliff from July through December, indicative of falling gas prices and people cutting back on the purchases of accoutrements such as drinks and sandwiches. In a similar fashion to grocery store sales, there has been a recent increase in spending at gas stations reflected by the price of gas jumping from near $1.50/gallon to around $2.00/gallon nationally.

Obviously, jewelry is far at the other end of the staple-discretion continuum, and is a good indicator of purely discretionary spending. It is pretty apparent, at least from this graphic, that this type of discretionary spending (in total dollars) is contracting rapidly, now at a year over year rate of around -22%. Massive discounting by many national and regional jewelers have certainly contributed to fewer total dollars spent as well.

Above, we notice the same tail in total retail sales starting at the beginning of 2009. This change in total retail sales correlates well with our data on consumer level inflation and brings the mainstream’s assertion of the re-emergence of the consumer into question.

Inflation Returns to Consumer Prices

In early January, a number of our in-house statistical indicators turned positive in terms of the spillover of monetary inflation into consumer prices and we discussed this issue in detail in 2/20/2009’s article “The Turning of the Tide?”:

“If we have indeed witnessed the inflection point where the trillions of dollars parked in investment and commercial banks are finally being let out to play, then our wealth and purchasing power are about to come under serious attack. Obviously the risk in putting such an assertion to paper is that if we return to the previous trend of falling prices even for a brief time, the entire construct will be discredited rather than the possibility that the timing was a bit off being acknowledged. There are some factors that would help us to confirm or deny that such an inflection point has taken place……”

Since those indicators went positive, we have received affirmation of our observations from PPI/CPI, the GDP Price Index or GDP Deflator, nominal retail sales, and import prices. It is the retail sales portion that applies here, and the key lies in how that report is interpreted. It absolutely must be remembered that almost all of these aggregate spending metrics report in total Dollars, NOT units. Nor are these numbers adjusted for ‘inflation’. They are adjusted for seasonal factors that are at the discretion of the reporting agency, but that is it. What this means is that increases in consumer prices (especially in staple goods since people are less likely to cut back) will be interpreted as economic growth when retail sales are reported because people are spending more money. Conversely, when prices fall like they did from July through December of 2008, the interpretation will be economic contraction.

So the question needs to be asked: Did people actually buy fewer goods and services (an actual retrenchment) over the past 6 months or did they just pay less for some of the things they purchased thereby causing retail sales to drop?

The answer is more difficult to find than one might imagine.

We know from the Advance GDP report on Wednesday of this week that personal income in the US dropped by an estimated $59 billion (2.0% annualized) as job losses put more and more Americans on the unemployment rolls. The rate of decay in personal income grew from $42.9 Billion or 1.4% annualized in Q4 2008.

The report also gleaned that personal outlays increased .7% in Q1 2009 after falling 9.5% in Q4 2008. Looking for example at the CPI for that period, we find that using the old CPI methodology that consumer prices increased 1.18% for Q1 2009. By extension then, if consumers would have purchased the exact same quantity of goods as they did previously, they would have spent 1.18% more yet they only spent .7% indicating that less goods/services were purchased. A terribly small cutback for sure, but certainly not the growth trumpeted by the mainstream media.

For comparative purposes let’s apply the same analysis to Q4 2008. Using the same CPI methodology as the previous paragraph, consumer prices dropped 2.93% in Q4 2008. So if consumers had bought the same quantity of goods/services, they would have spent 2.93% less. Yet consumers spent 9.5% less indicating a significant cutback.

One conclusion we can draw from this cursory analysis is that while consumers spent more in Q1 2008, they didn’t really buy more. Still, in the face of rising unemployment, falling housing prices, and general economic malaise, consumers are still trying hard to hold onto yesteryear after a very brief period of belt-tightening.

In our ‘Spin Cycle’ podcast, we are currently doing a 7-part series in which we depict the factors affecting the US economy as sides of a Rubik’s Cube – independent, yet interrelated. Episodes include Interest Rates, Economic Growth, Debt/Monetary Growth, Energy, Demographics, Geopolitics, and the State of the Consumer. To listen, visit www.my2centsonline.com/radioshow.php

It is really no wonder that thousands of people across the nation showed up Wednesday to protest everything from the $787 stimulus package to big bank bailouts done under the cover of darkness. A failing economy, a government determined to insert itself fully in the specter of control, state sovereignty movements, and a good old fashioned tax day frown all combined to whip up enough ire to get folks to take to the streets. Still, many in the media don’t understand why this wave of protest is occurring.

Main Street Under Pressure

Since last summer there have been fairly regular stories even in the mainstream press about banks cutting limits on credit cards. It would seem as though the bankers had decided that the age of consumerism had gone too far. Ironically, these actions happened concurrently with the largest giveaways in the history of mankind. In the past 9 months the United States, #1 on the world financial stage, has committed an entire year of economic output to stem the ongoing crisis. How do banks respond? By cutting credit card limits. It is like giving a small child sweets until the kid is in a frothing sugar-frenzy, then locking up the candy dish. The analogies are nearly limitless, but the point is obvious. While the banks screamed for the elixir of easy Fed credit, they slammed the door on Main Street. For their part, consumers at some levels have cut back on their spending, which is a good thing. The unfortunate reality is this: Even the most prudent and responsible consumer will have a bad month. There will be a string of unexpected expenses, and that individual might need to carry a balance for a while to get things straightened out. Job losses will cause exactly this type of situation and now in many cases the credit is not there.

Another unintended consequence is that when credit lines are cut, utilization goes up and suddenly the most frugal appear to be on a spending bender. Take the person who has $25,000 in total credit from a number of different sources. Say on average the individual uses $5000/month for regular expenses, but never carries a balance. Now let’s assume that their lines are cut in half. Their utilization just doubled from 20% to 40%. Their new application for a small business loan might now be rejected because they’re judged to be a bad credit risk due to the 40% utilization. More unintended consequences.

Another amazing development has been the continuation and acceleration of foreclosure activity despite all the political rhetoric over the past 15 months from both sides of the aisle in terms of ‘helping’ homeowners. According to RealtyTRAC, foreclosure activity, which includes default notices, repossessions, and auction sale notices, increased 6% from January 2009. This same measure increased nearly 30% from February 2008. So despite trillions of dollars pledged to Fannie, Freddie, Bobby, Lulu, and anyone else with a leaky balance sheet to supposedly assist homeowners, not only is foreclosure activity not abating, it is increasing.

Runaway government spending

As most are acutely aware this tax day, their contribution to the team effort of bailing out the economy will not be near enough. Not only will their continued (and increasing) participation be needed, but that of their children, and grandchildren will be required as well. While I could sit here and tally up the various tabs, totals, and sums, it would be pointless. The public is mind-numb from hearing these staggering figures. It is very difficult to even fathom a billion let alone a trillion. However, this reality has dawned on an increasing number of people over the past few months and they are understandably perturbed. We have hopefully learned a valuable lesson, and that is that liberty is akin to a seedling. It is planted, but then must be watered, fed, and protected from the harsh environment in which it lives. While Americans were out collectively living it up over the past umpteen years, that harsh environment has wreaked havoc on our seedling. The bad news is that we’ve got a lot of work to do. Hopefully the sheer magnitude of our task doesn’t discourage us from doing it.

Big Bank Profits = Bubble Watch

After 6 quarters of dire forecasts, failures, predictions of failure, and uncounted bailouts, big banks are suddenly earning money again. Interestingly enough, most of these newfound profits are coming from the investment banking sides of their businesses. Translated, that means they’re back to their old tricks again and it is back to business as usual. Secure in the knowledge that their backs are securely covered by ‘We the People’ and without fear of extinction, the winners of the 2008 financial crisis have been refreshed, revived, and are back at it. Since our economy and monetary system are still compromised by the same structural imbalances that existed before the crisis, it is again time to go on “Bubble Watch”. The ingredients are there: very cheap money from the Fed and existing dislocations in many markets. The only thing missing is you. And this little fact could cause quite a problem. Americans, quickly growing weary of the accelerating boom-bust cycles, and still punch drunk from the last beating are not likely to be as willing to participate in the next bubble.

One of last fall’s pieces focused on the causes of the Great Depression and tried to dispel the myth that the market crash of 1929 was somehow solely responsible for the mess that followed. We pointed to a nagging reality from 1929 and that was the proportion of Americans living in poverty. More than half were living below a minimum subsistence level, which at the time was $750/year. Essentially one half of the population was unable to support further economic growth. That was one of the underlying structural imbalances. The crash and subsequent misguided government responses were the triggers that caused the Depression.

How much different are we really today? Sure, the poverty line has been adjusted upwards in nominal terms, but fundamentally, how many Americans are below it now? Perhaps the most important variable that has changed in the past 70 years is the reliance we have on credit as a society. How many of us would be living below the poverty line, unable to participate in the economy were it not for VISA, Mastercard, and equity lines of credit? The recent spikes in unemployment will only exacerbate the situation, causing further reliance on credit for subsistence; credit which is shrinking by many measures.

In conclusion, it is particularly disheartening that nearly all of the political focus spanning the last two administrations has been about getting credit flowing again, with only token talk of job creation and fostering legitimate economic growth. The actions have been no better. The vast majority of bailout and stimulus dollars have gone to the financial system to encourage lending and borrowing rather than to the real economy. Our fiat monetary system’s reliance on debt for its growth is the elephant standing in the room each time a press conference or media event is held. It is the elephant nobody in charge wants to talk about. It is the question nobody in media wants to ask. And, at the end of the day, I would imagine that is why so many people came out on Wednesday and will continue to do so. They aren’t interested in parties. They just want to talk about elephants.