The Consumer Leads the Economy
12/15/08
The producer price index for November largely met expectations, falling 2.2% against forecasts for a decrease of 2.0%. Producer prices have fallen massively and remain under immense downward pressure as a result of weak economic activity worldwide. Prices of crude materials - goods at the earliest stage of the production process - fell 12.5% in November overall and a massive 20.4% excluding food and energy. These price declines will then trickle down to semi-finished goods and then finished goods. Producer prices thus look likely to continue to decrease in the months ahead. I think we can safely predict that the consumer price index for November will also show a significant decline in retail prices. Some conspiracy theorists may claim of course, that the government continues to lie to us and that inflation is really much higher than the minus 1.5% that the markets expect. Retail sales fell 1.8% in November overall and 1.6% excluding automobiles, figures that were both two-tenths of a percentage point better than expected. Nevertheless, the consumer continues to retrench. Vehicle sales dropped to an annual rate of just above 10 million vehicles sold per year. Sales volume this low has last been seen in 1982 and that was with a population below 250 million. Today's population has exceeded 300 million several years ago. In other words, vehicle sales per capita are much lower. The consumer continues to be front and center of the recession and unless the consumer recovers, the economy is not going to recover either. It is really that simple.
Marc Chandler wrote an interesting piece in Real Money the other day. In it he basically posits that the Great Depression of 1929 and today's crisis "are linked by macroeconomic similarities beyond the dramatic deterioration of credit condition. The economic expansions that preceded both the 1929 crash and the more recent one were both driven by consumption, especially of durable consumer goods, rather than investment. And in both cases, the increase in effective demand was fueled not by higher real wages and salaries but by increased consumer credit." I find his thoughts very intriguing, but they are controversial, because he disabuses readers of the notion that lower tax rates and private investment may improve the economic crisis. He continues: "Consumption accounts for more than two-thirds of the U.S. economy and government spending accounts for the vast majority of the remainder. Contrary to inherited wisdom, there appears to be no correlation between lower corporate taxes, increased net investment and economic growth. Indeed, growth has consistently been recorded even as net investment has fallen. ... If the credit crunch is indeed a symptom of deeper structural forces, then the solution now, like the 1930s, is to promote consumption through fiscal policy (tax incentives to purchases of consumer durables, a cut in payroll taxes), higher and longer unemployment compensation and massive public investment. Relinking wages and salaries to productivity growth is not simply a function of fairness, but an issue of economic necessity." Well put! Consumer demand has vanished because to much credit, falling home prices and until recently high energy costs took up every available dollar in consumers pockets. The collapse in demand manifests itself in many other statistics. The Institute for Supply Management (ISM) issues a host of indices. The two main indicators are the Manufacturing ISM Index (formerly known as Purchasing Managers Index) and the Non-Manufacturing ISM Index. The Institute's Business Survey Committee, composed of more than 300 purchasing executives from across the country, provide the data. Members of the committee respond to a monthly questionnaire designed to elicit fact, not opinion, about changes in production, new orders, new export orders, imports, employment, inventories, prices, lead-times, and the timeliness of supplier deliveries in their companies comparing the current month to the previous month. Similar methods are used for the non-manufacturing index.
The correlation between chain-store sales and the ISM-Index is very strong, and chain-store sales that cross above 3% on a year-over-year basis tend to be associated with an ISM of 50, a level that indicates economic expansion. You can see that the manufacturing index is also much weaker, caused almost certainly by the slump in car sales and the weakness in Detroit. The service sector however is also very weak. Falling end demand causes falling demand for intermediate goods (i.e. falling ISM-Index) which in turn causes rising unemployment, which in turn reduces income, falling demand and so on. Below is the unemployment part of the picture.
The economy is caught in a vicious, self-reinforcing cycle. Aggregate consumer demand needs to be stimulated but the consumer is too extended to purchase more consumer durable goods. But there is hope because there always is. The last chart shows us the Real (inflation adjusted) average weekly earnings of full-time and part-time workers holding production or non-supervisory jobs. You can see that during the past 4 recessions, average weekly earnings jumped right at the end. This could indicate that the consumer is already on the mend and that this recession may come to an end after all.
Hermann Vohs
"Do give books - religious or otherwise - for Christmas. They're never fattening, seldom sinful, and permanently personal."
Lenore Hershey
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
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