Sunday, March 29, 2009

US Consumer, 1929, and 2008: Are we in trouble?

The horizontal axis in my homemade chart represents a monthly timeline, with 0 corresponding to market peaks in 1929 (blue line) and 2008 (red line). The vertical axis is a log scale with 1 being the market high.

A few notes about the blue line:
  • The market did not reach its 1929 peak value during the next 10 years depicted in the chart. Markets regained the 1929 high in 1954, or 25 years after the fact.
  • The market reached bottom in 1932, 3 years after the crash began.
  • There are many temporary periods where the market went up for some reason. These temporary upticks do not establish a long-term trend. As implied above, the long-term trend was a very slow, prolonged recovery.
The chart below tracks total consumer debt from 1952 through the end of 2008 as a percentage of GDP (source of this and other similar graphs is WSJ).

Let's separate out consumer debt into real estate and credit card tranches (there are other types of debt, but their value is negligible compared to these two debt categories).

There are two curious elements that jump out from the above chart:
  • Real estate debt dwarfs credit card debt and appears to have peaked (this is good).
  • Credit card debt is steadily increasing (this is bad).
So, what is going on? Let's look at another, related chart first:

Owner's equity in real estate has dropped precipitously from a 1952 peak of 80% to approximately 45% today. This drop in owners equity matches the increase in home mortgage loans that you see above.

Let's go back to the question: What is going on with consumer debt?

In normal times, real estate equity values would have an inverse relationship to real estate debt; however, home mortgage debts are dropping at the same time as home equity in the past few quarters (look at the tail-end of both graphs). This means that real estate debt is dropping mainly due to an increase in foreclosures, not because the consumer is in a better financial shape or paying back his debt.Regarding the consumer paying back his debt: He is actually taking on more debt because credit card liabilities are increasing.

So, what is going on? The US consumer is in trouble.

Let's go back t the red line in the first chart. Consumers are the underlying reason why the economy functions. There is a person at the end of every dollar. Today, just like 1929, the consumer debt to GDP ratio is nearly 100%, and all signs point to continued financial weakness with the US consumer. In the meanwhile, expect unemployment numbers to increase. Now you can connect the dots, or if you will, extrapolate the red line into the future (hint: the blue line is a good indicator).

The good news: The 2008 downturn is likely to be more muted than the 1929 downturn due to systemic economic improvements. The downward trend will not be as steep as it was in 1929.

The bad news: We have a structural problem with consumer spending and savings patters in this country. Fixing our current situation will take a long time because we are dealing with real estate debt, personal spending patterns, may years of accumulated debt, and so forth. This problem took a long time to make and will take a long time to resolve. Again, look to the blue line as an indication of the future.


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steve.weston said...

Very nice, clean, and powerful explanation of the present and future consumption. One thing that differs from 1929, which only offers a slight glimmer of hope is that our government is doing everything it possibly can to avert a depression. It has only made one mistake so far and that was letting LB fail. The government however, quickly learned from this and now will do anything to prop up AIG,