Market Directions

Obscured in the gloom of Friday’s Non Farm Payrolls was an even more downbeat assessment of the state of the United States economy.

Recessions: One Down, One to Go

Obscured in the gloom of Friday’s Non Farm Payrolls was an even more downbeat assessment of the state of the United States economy. The American consumer remains in recession. This critical judgment comes directly from America’s households.

Consumer credit contracted by $17.5 billon in November. That is the tenth straight month that Americans have decided to pay down debt and it is the longest negative run in the 66 year history of the series. Not only did consumers choose repayment over consumption but it was the largest monthly drawdown on record. Corporate profitability may be exciting Wall Street but with unemployment at a generational peak there is no optimism for the American worker and consumer.

Monthly Consumer Credit Net Change (Billion $)

The disappointment over the -85,000 headline Non Farm Payrolls number obscured even more troubling figures within the report. The unemployment rate was stable at 10.0% because the number of workers seeking positions fell by 661,000 not because those losing and finding jobs were equal. If these workers had remained under the Bureau of Labor Statistics (BLS) count the unemployment rate would have risen to almost 10.4%. Those workers will eventually return to the job hunt and the unemployment rate will surge when they do unless they are quickly enlisted in the work force. Participation in the labor force fell to 64.6% in November from October’s 64.9%. Household employment which records small business jobs, and is the primary engine for new employment, dropped by 589,000 after rising modestly in October.

Despite the end of one year of negative GDP with the 2.2% expansion in the third quarter and the fourth quarter’s 4% estimate employers are not hiring. The virtuous circle when anticipation of future consumption and consumer spending prompts employers to add staff while the choice of employees is high and the costs low can also play in reverse. Expectation of a prolonged period of static or low consumption will retard employment planning as firms focus on continued improvement in productivity per worker. The endless legislative process in Washington has not helped and has probably inhibited hiring as firms cannot assess future tax and regulatory costs when their final legal obligations are unknown.

Businesses have survived a traumatic environment for more than two years by slashing costs and staff and vastly improving productivity. Firms are now naturally cautious about increasing spending and perhaps even a little surprised at the success of their productivity efforts. If anything could convince reluctant business planners that a robust economic recovery was around the corner it would be a substantial rebound in consumer spending. But by any standard that has not occurred.

Federal Reserve officials have said that tighter bank lending standards and credit line reductions are hindering consumer spending. But the logic of that analysis is weak. It is largely concern for their future earnings and the consequent concern for present debt levels that is driving consumer decision making.

The choice to reduce the debit side of household balance sheets is voluntary. It is made by people who have discretionary funds, who are still employed. Banks do not write to credit cards holders, from whom they are collecting hugely profitable interest charges, advising them to reduce their overall balances. Consumers have made the analysis themselves.

When the recession began the amount of consumer debt was already established. The motivation to pay down credit balances was not irrevocable; consumers could have simply chosen not to expand their current indebtedness or they could have continued to add to their credit sheets.

In the ten months since January consumers have subtracted from their overall debt balance every month. It has been revolving credit, which includes cards and most individual short and medium term debt that has fallen each month. Consumers have reduced revolving debt every one of the fourteen months since the Lehman bankruptcy last September. The consumer reaction to the financial crisis has been immediate, sustained and one way.

Monthly Revolving Consumer Credit Net Change (Billion $)

In contrast non-revolving credit (fixed amount, fixed term) has grown in three of the ten months since January and in two was barely negative (less than -$1 billion). If we include the last quarter of 2008 it has been positive is six of the past fourteen months.

It is the consumption side of consumer spending, as opposed to the investment portion that has absorbed the vast majority of the reduction in debt. This is income that would normally be available for plasma screens, trips to Disneyland and the mall, video games and restaurant meals. The income has not disappeared but the utilization has dramatically altered.

The average monthly revolving debt retirement has been remarkably consistent, indicating that it is determined by available income and the level of total outstanding debt and has not by the varying prospects for the stock market, the job picture or the economy in general. In the fourth quarter of 2008 consumers retired an average of $5.94 billion each month; in the first quarter of 2009 $7.69 billion; in the second quarter $7.52 billion; in the third quarter $5.55 billion. In the first two thirds of the fourth quarter the monthly payback amount jumped to $10.53 billion, but that amount may well revert to the mean on revision. If it does not then it is possible that consumer attitudes have taken another turn for the worse.

The difference between the acquisition and retirement of consumer revolving debt pre and post Lehman is striking. In the four quarters after September 2008 consumers paid back an average of $6.7 billion in revolving debt per month: in the previous two years they had increased the same debt an average of only $4.6 billion per month.

In spite of the virulent recession, massive job losses, huge reductions in wealth and general economic gloom Americans somehow managed to increase their monthly debt retirement by 46% of their previous monthly credit extension.

This effort speaks of an extraordinary motivation and a high level of fear and discomfort with household debt levels. Until consumers are again comfortable with their level of debt the second recession, the consumer recession cannot end; and until it does the end of the first recession is almost moot.