A Consumer Economy at a Standstill

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This recovery is wonderful in every way, except the important ones. It is like a shiny new airplane. It has glossy aluminum wings. It has plush seats in the first class section. Trim stewardesses serve drinks. Movies are available on demand in all sections.

A majority of those polled by Bloomberg think things are great; 61% said they thought they economy had taken off and was flying high. Stocks are up. Commodities are up. And here’s another Bloomberg headline: “Global investors give Federal Reserve Chairman Ben S. Bernanke top marks…”

The recovery has won the approval of economists and the public. It has almost everything going for it. It just won’t fly!

Comes news this morning that the US economy is still on the runway. This report from the AP explains why:

“Consumers slashed their borrowing in July by the largest amount on record as job losses and uncertainty about the economic recovery prompted Americans to rein in their debt.

“Economists expect consumers will continue to spend less, save more and trim debt to get household finances decimated by the recession into better shape. Such behavior, though, is a recipe for a lethargic revival, because consumer spending accounts for 70 percent of economic activity.

“The Federal Reserve reported Tuesday that consumers in July ratcheted back their credit by a larger-than-anticipated $21.6 billion from June, the most on records dating to 1943. Economists had expected credit to drop by $4 billion.”

Hey, not bad…economists were only off by 430%. Consumers are paying down debt more than four times faster than they thought. Partly because they want to. And partly because they have to. They don’t want to borrow…and banks don’t want to lend to them anyway. Consumer credit is falling at a 10% annual rate, based on July figures. Credit card debt is going down at an 8% rate.

When they pay down a dollar’s worth of debt that is one dollar less in the consumer economy. But it’s also a dollar that is not borrowed. Where the consumer spent all his income two years ago…and borrowed more so that he could increase his consumption even further…now, he doesn’t borrow…and he doesn’t spend all his income either. Now, the money that used to pour into consumer spending leaks out.

As we reported yesterday, personal spending is dropping…the figures were down in four of the last six quarters — something that has never happened before, since they began keeping records in 1947. And the level of consumer spending is down 33% from a year ago — with discretionary spending now down to a level it hasn’t seen in 50 years.

Of course, that’s just what we’ve been saying. The great credit expansion began in 1945. It ended in 2007. Credit will contract for many years. One study, also reported here, suggested that consumers would spend 14% less — even after the economy was back on its feet. We estimate that the total level of debt must go down below 200% of GDP. If that’s correct, we need to pay down about $25 trillion of debt. That won’t be easy and it won’t be quick.

And it will mean high levels of joblessness for a long time. Already, two out of five working-age Californians are unemployed. The other three are working the shortest workweeks in history. No wonder; with spending dropping, sales are falling. So businesses don’t need so many people to make, ship, sell and service their products. Then, of course, when they lay off workers to cut expenses, the unemployed workers have to cut spending!

How is it possible for a consumer economy to grow when consumers are spending less money? Of course, it’s not. This is not a genuine recovery…it’s an impostor. A fraud. A recovery impersonator.

While the private sector is paying down debt, the public sector is adding debt at a ferocious pace — about $150 billion per month. Public spending isn’t the same as private spending. It is usually spending for things that people wouldn’t buy if they had a choice.

And it comes with a whole new risk attached — the risk that the feds will inflate their way out of debt rather than pay it off.

Government spending does not bring a durable, real prosperity. (If it did…think how easy it would be to make people rich; governments love to spend money!) It may look like a recovery. It may have shiny wings and spiffy-looking stewardesses. But it won’t fly.

The World Economic Forum has taken the United States down from the number one position. America is no longer the world’s u201Cmost competitiveu201D economy. That title goes to Switzerland.

Meanwhile, the US banking system is rated #109 in the world — just below Tanzania.

“More than one in four US banks announced an unprofitable quarter,” Strategic Short Report’s Dan Amoss tells us.

US banks became leveraged casinos during the bubble years. They’ve still got a lot of leverage…and are still trying to relive those glory days when players lined up to spin the wheel…and free drinks flowed by Niagara Falls.

Dan will certainly find the best way to play the downfall of US banks — after all, he did call the collapse of Lehman six months early — leading his readers to as much as a $200,000 profit. Look for regular updates on the banking industry from Dan in these pages…

Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century and Empire of Debt: The Rise Of An Epic Financial Crisis and the co-author with Lila Rajiva of Mobs, Messiahs and Markets (Wiley, 2007).

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