If America sneezes, who catches a cold?
Something about financial markets.
There have been some interesting data releases and developments this week, some of which have slipped under the radar. In my view, these have far greater significance than the markets allow, mainly because their impact falls in the medium term (around 12 months out) and traders have clearly focused on "the next big thing", i.e. very short-term indicators (US CPI, Philly Fed) which suggests confusion about the strength of the US economy, the global economy, and hence the likely course of the Fed (and the ECB) in the coming months.
The Fed itself continues to express optimism about the outlook for the US economy, citing good jobs creation (apparently) and strong GDP growth. It expresses moderate concern about price pressures, citing evidence that some businesses in some regions are able to pass on cost increases to the consumer. Maybe because of this optimism, most bloggers express views in contradiction of this. There are pages and pages of analysis and discussion, charts and statistics, which purport to show that the end is nigh. Clearly the Fed is trying to look past the chaff to focus on the wheat, and it is a useful exercise to drown out market "chatter" to identify those items that will have a real (and possibly significant) impact on our economic outlook. But is what the Fed sees valid, or is the Fed trying to talk-up economic sentiment (as the ECB constantly did through 2004, to little avail) to avoid the self-fulfilling descent into economic gloom?
What can be said about the current outlook, without putting a partisan bias on it? It is still a given that the US consumer is dragging the rest of the world along, by consuming more of what everyone produces than any other country (or group of countries); China is still the important supplier, but is only the end of the chain in terms of raw materials (provided by the various commodity producing countries) and indeed components, machine tools and technology (provided largely Europe and Japan). For much of it's exports to the US, China merely assembles and sells, and thus we are all reliant on the continuing strength of the US consumer.
How is the US consumer doing? There has been plenty of analysis of the level of debt held, about the debt/earnings ratio, and the ability to service the debt. Leaving all that on one side (blotting out the market chatter), the truth is that he/she has confounded the bears by managing to maintain consumption levels well beyond what has been thought to be possible. John Mauldin, a commentator of some insight (www.frontlinethoughts.com) has been saying for some time that the US could be described as a muddle-through economy, not strong enough to break out, but not crippled either. Could this be about to change, one way or the other?
I believe two things determine a willingness to spend in order to consume: access to money to spend (sounds obvious, but it is important if that money is not yours, i.e. it is borrowed), and the feeling that spending that money is OK - the reward from spending is greater than the anxiety created by the debt, or indeed, not saving. I am sure there are equations to explain at what point the reward/anxiety ratio turns negative (and curtails spending), but this will depend on personal outlook, which is why sentiment surveys have become so important for traders of stocks and bonds. Personal outlook changes as things pop into view that were not being considered - higher taxes, inflation, redundancies, bigger bonuses (not everything is negative), so peoples' propensity to spend changes even if disposable income remains constant.
So, what are the significant things I mentioned above? Before I cover them, first what is the status quo in the US:
Consumer spending has been achieved through borrowing, by and large; some via re-financing (i.e. equity withdrawal from houses), and some more straightforward credit card borrowing.
Job creation appears to be quite strong; however, there is some mystery surrounding the probity of this data - the official non-farm release contains a modelled figure for new jobs created by small business start-ups. This figure is fictional, and is revised on a six-monthly basis to try and put some hard fact into it, although it is up for debate whether this is achieved or not.
What is certain is that manufacturing is losing jobs, and the service sector is where they appear to be being created. And it seems that many of these jobs are at the low end of the pay scale.
Which is where we get to the two nuggets extracted from the week's releases:
1. Average weekly earnings in the US fell by 0.3% in March, and for the 12 months through Feb 2005 fell by 0.5%; this means that 80% of the workforce has earnings that are shrinking, and by more than the headline if inflation is added to the mix.
2. The Comptroller of the Currency (where do they get these titles?) is pressing credit card companies to up minimum repayments from 2% of the balance to 4%; this is to ensure that an element of the principal is repaid, rather than just the fees, which allowed the principal to be rolled over month to month.
There are lots of other items which impact on the consumer (look into the new bankruptcy laws which the Senate passed recently), but I often think that the big changes are at the margin, because that is where the impact was least expected. Everyone is waiting for the consumer to say "enough is enough" as rates rise, and stop spending, when in fact it may be that the higher charges are ignored while they can be met, but the day the weekly pay packet does not feed and clothe the kids as well as meet the new 4% payment on the credit cards, that's when the consumer wakes up.
If America sneezes, who catches a cold?
The older readers may recall the saying: If IBM sneezes, America catches a cold. I think this has morphed into my headline above. The debate is now on whether America has sneezed or not; by my reckoning, it has, but the data is yet to show this, so it is merely an opinion. Still, manufacturing is obviously up the swanee, and with GM responsible (directly or indirectly) for huge numbers of people (and only the most visible company of a long list), the decline and fall of the US consumer is imminent. Other sectors are not taking up the slack. This is just becoming visible elsewhere, but most clearly in Europe.
With the rally in the euro last year, export industries in Europe were squeezed; with the natural time-lag, this is just becoming apparent now, with growth forecasts being trimmed by governments, central banks and think-tanks. With domestic demand not growing, and in some cases falling (UK & France showed steep declines this week), the impact has begun to be felt, and it may be about to accelerate.
China, and Asia as a whole, is harder to judge. China in particular does not use a Western model of economic management. Despite the shift from central control to a capitalist approach, large Chinese companies appear to be used to mop up large numbers of surplus workers (as does the public sector in the UK and Europe), and are not run to make a profit. Attempts to turn the average Chinese into a consumer are having mixed results - of the $22bn in car loans made to individuals since 2000, 50% are in default. China needs to absorb the workforce, or face considerable political instability. The US is absorbing large amounts of Chinese output, and thus helping that stability. If it stops, no one can predict the outcome.
In conclusion, there are several signs that the US consumer is squeezed; there are factors in the pipeline that will make this situation worse. The US consumer can retrench, and US industry will have to restructure, and the process will be painful. However, for those countries relying on the US, and without domestic demand to cushion the blow, the pain could well be a lot worse.
There have been some interesting data releases and developments this week, some of which have slipped under the radar. In my view, these have far greater significance than the markets allow, mainly because their impact falls in the medium term (around 12 months out) and traders have clearly focused on "the next big thing", i.e. very short-term indicators (US CPI, Philly Fed) which suggests confusion about the strength of the US economy, the global economy, and hence the likely course of the Fed (and the ECB) in the coming months.
The Fed itself continues to express optimism about the outlook for the US economy, citing good jobs creation (apparently) and strong GDP growth. It expresses moderate concern about price pressures, citing evidence that some businesses in some regions are able to pass on cost increases to the consumer. Maybe because of this optimism, most bloggers express views in contradiction of this. There are pages and pages of analysis and discussion, charts and statistics, which purport to show that the end is nigh. Clearly the Fed is trying to look past the chaff to focus on the wheat, and it is a useful exercise to drown out market "chatter" to identify those items that will have a real (and possibly significant) impact on our economic outlook. But is what the Fed sees valid, or is the Fed trying to talk-up economic sentiment (as the ECB constantly did through 2004, to little avail) to avoid the self-fulfilling descent into economic gloom?
What can be said about the current outlook, without putting a partisan bias on it? It is still a given that the US consumer is dragging the rest of the world along, by consuming more of what everyone produces than any other country (or group of countries); China is still the important supplier, but is only the end of the chain in terms of raw materials (provided by the various commodity producing countries) and indeed components, machine tools and technology (provided largely Europe and Japan). For much of it's exports to the US, China merely assembles and sells, and thus we are all reliant on the continuing strength of the US consumer.
How is the US consumer doing? There has been plenty of analysis of the level of debt held, about the debt/earnings ratio, and the ability to service the debt. Leaving all that on one side (blotting out the market chatter), the truth is that he/she has confounded the bears by managing to maintain consumption levels well beyond what has been thought to be possible. John Mauldin, a commentator of some insight (www.frontlinethoughts.com) has been saying for some time that the US could be described as a muddle-through economy, not strong enough to break out, but not crippled either. Could this be about to change, one way or the other?
I believe two things determine a willingness to spend in order to consume: access to money to spend (sounds obvious, but it is important if that money is not yours, i.e. it is borrowed), and the feeling that spending that money is OK - the reward from spending is greater than the anxiety created by the debt, or indeed, not saving. I am sure there are equations to explain at what point the reward/anxiety ratio turns negative (and curtails spending), but this will depend on personal outlook, which is why sentiment surveys have become so important for traders of stocks and bonds. Personal outlook changes as things pop into view that were not being considered - higher taxes, inflation, redundancies, bigger bonuses (not everything is negative), so peoples' propensity to spend changes even if disposable income remains constant.
So, what are the significant things I mentioned above? Before I cover them, first what is the status quo in the US:
Consumer spending has been achieved through borrowing, by and large; some via re-financing (i.e. equity withdrawal from houses), and some more straightforward credit card borrowing.
Job creation appears to be quite strong; however, there is some mystery surrounding the probity of this data - the official non-farm release contains a modelled figure for new jobs created by small business start-ups. This figure is fictional, and is revised on a six-monthly basis to try and put some hard fact into it, although it is up for debate whether this is achieved or not.
What is certain is that manufacturing is losing jobs, and the service sector is where they appear to be being created. And it seems that many of these jobs are at the low end of the pay scale.
Which is where we get to the two nuggets extracted from the week's releases:
1. Average weekly earnings in the US fell by 0.3% in March, and for the 12 months through Feb 2005 fell by 0.5%; this means that 80% of the workforce has earnings that are shrinking, and by more than the headline if inflation is added to the mix.
2. The Comptroller of the Currency (where do they get these titles?) is pressing credit card companies to up minimum repayments from 2% of the balance to 4%; this is to ensure that an element of the principal is repaid, rather than just the fees, which allowed the principal to be rolled over month to month.
There are lots of other items which impact on the consumer (look into the new bankruptcy laws which the Senate passed recently), but I often think that the big changes are at the margin, because that is where the impact was least expected. Everyone is waiting for the consumer to say "enough is enough" as rates rise, and stop spending, when in fact it may be that the higher charges are ignored while they can be met, but the day the weekly pay packet does not feed and clothe the kids as well as meet the new 4% payment on the credit cards, that's when the consumer wakes up.
If America sneezes, who catches a cold?
The older readers may recall the saying: If IBM sneezes, America catches a cold. I think this has morphed into my headline above. The debate is now on whether America has sneezed or not; by my reckoning, it has, but the data is yet to show this, so it is merely an opinion. Still, manufacturing is obviously up the swanee, and with GM responsible (directly or indirectly) for huge numbers of people (and only the most visible company of a long list), the decline and fall of the US consumer is imminent. Other sectors are not taking up the slack. This is just becoming visible elsewhere, but most clearly in Europe.
With the rally in the euro last year, export industries in Europe were squeezed; with the natural time-lag, this is just becoming apparent now, with growth forecasts being trimmed by governments, central banks and think-tanks. With domestic demand not growing, and in some cases falling (UK & France showed steep declines this week), the impact has begun to be felt, and it may be about to accelerate.
China, and Asia as a whole, is harder to judge. China in particular does not use a Western model of economic management. Despite the shift from central control to a capitalist approach, large Chinese companies appear to be used to mop up large numbers of surplus workers (as does the public sector in the UK and Europe), and are not run to make a profit. Attempts to turn the average Chinese into a consumer are having mixed results - of the $22bn in car loans made to individuals since 2000, 50% are in default. China needs to absorb the workforce, or face considerable political instability. The US is absorbing large amounts of Chinese output, and thus helping that stability. If it stops, no one can predict the outcome.
In conclusion, there are several signs that the US consumer is squeezed; there are factors in the pipeline that will make this situation worse. The US consumer can retrench, and US industry will have to restructure, and the process will be painful. However, for those countries relying on the US, and without domestic demand to cushion the blow, the pain could well be a lot worse.
posted by Jambutty at 7:42 am
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