Friday, September 11, 2009

It's The Economy, Stupid!

Today's subject: a bird's-eye view of the US economy (it's a big economy, so the bird sees a lot and the post is, necessarily, quite long).
  • Comparing the pre-recession economy in 2006 with 2Q2009, the country's GDP is made up as follows (all numbers in current dollars):
Data: BEA

From this perspective, the major - in fact, the only - negative development in the economy is a plunge (-33%) in gross private investment, i.e. spending on plant, equipment and services by the country's businesses plus investment in residential property (i.e. homes). Personal consumption held up well, government spending rose significantly and net exports became a much smaller negative factor, as the trade deficit shrunk fast (but this is no cause for macro economists to celebrate since it came about due to (a) lower imported crude oil prices and (b) fewer imports of consumer goods).
  • The next chart breaks down the economy in sectors, percentage-wise:
While personal consumption is still around 70% of GDP, private investment has been slashed and is now only 11% of GDP vs. 17.4% three years ago. Simply put, businesses and individuals are investing much less: in dollar terms, during the second quarter of 2009 they spent $800 billion fewer dollars than in 2006 (annualized figures). Government has taken up part of the slack, but the single biggest "positive" change between 2006 and 2009 has come from net exports, which are now a smaller negative by a whole 3.34 percentage points. Again, this is basically a "mirage" positive development and translates to no tangible gain for the day-to-day lives of working Americans, no matter what the macro GDP numbers may say.

Let's pause here.

From the above, we see that what has happened so far in this "crisis" is this: businesses and individuals slashed investment by an enormous amount, causing overall GDP to drop sharply and very fast. In round figures, a 33% decline in private investment - which made up 17% of GDP - produced a 6% decline in GDP. This was partially counterbalanced by government spending (Keynesian intervention) and by the large accounting entry of a shrinking trade deficit. Personal consumption, by far the largest component of GDP, was largely unaffected. That's where we are right now - the completion of Phase A, as it were.

But what is the future direction of the economy? In my view we are about to enter Phase B, one that will be shaped by the current rapid increase in unemployment and the resulting pull-back in personal consumption.
  • U-6 is the measure of unemployment that includes those marginally attached to the economy, discouraged workers and those working part-time because they can't find full-time work. It has shot up to 17%, more than one in six Americans in the workforce. Notice how the difference between U-6 and U-3 (the commonly cited figure for unemployment) has widened out from 2.5% to 7.5%, meaning that actual conditions in the job market are much tougher than U-3 alone indicates and certainly tougher than during other recessions.

  • This difficult situation is finally hitting personal spending: look at the chart of payrolls and personal consumption below. Spending has only turned negative in the beginning of 2009 but it is, understandably, well correlated with shrinking payrolls.
Personal Consumption Expenditures and Payrolls Are Tightly Correlated

Remember, personal consumption is the Holy Grail of the economy - it makes up 70% of GDP - so even a slight drop in personal spending translates into a large decline in headline GDP. Let's look closer at this Holy Grail..
  • Personal consumption is made up of Services (68%), Non-Durable Goods (22%) and Durable Goods (10%), (see chart below, click to enlarge). Not surprisingly, durable goods have taken it on the chin: cars, furniture, appliances - but that's only 10% of overall spending. Non-durable goods, things like clothing and food, are also down but significantly less, whereas spending on services is still growing, albeit at a much slower pace.

PCE and It's Components

Such consumer services make up nearly 50% of the economy (68% of 70%) and this sector is still growing, at around 1% per year. It makes sense, if we consider how people react to economic difficulties: they immediately stop big purchases like cars and appliances (the credit crisis is at play here, too), then smaller ones like unneeded clothing, cosmetics, etc. and finally slow down on things like vacations, movies and dining out. Health care is, obviously, going to be cut last.

So, for Phase B this is the crux of the matter: what is going to happen to consumer services?

Again, we need to drill down on the data, where services are broken down into:

Housing services: 28%
Health services: 24%
Financial services: 12%
Food services: 9%
Recreation services: 9%
Transportation services: 4%
Other services: 14%

Housing and financial services (taken together, 40% of total services) are connected through the mortgage and home equity loan links. No great prospects there for the foreseeable future. Health services make up a massive 24%, a proportion that has more than doubled since 1960 (see chart below, click to enlarge). As I pointed out in previous posts, I see this sector as having reached a peak and likely to deteriorate as an engine of growth - the Obama plan is an obvious warning flag.

Breakdown Of The Consumer Services Sector

Thus, two thirds of the consumer services sector of the economy (remember, this is 50% of GDP) is going to be facing headwinds. Let's see what growth looks like in each of the service sectors (see chart below, click to enlarge).

Consumer Services Sectors, Y-O-Y Growth

There are only three service sectors that are, in fact, still growing, though at lower rates than previously: Health, Housing and Other. I can't predict anything about the catch-all "other", but health and housing are obvious targets for negative developments in the near future, as I already discussed.

Everything else that matters in the private sector of the economy is already in negative territory and all that remains is Health, Housing and Other services, together making up a massive 33% of GDP. And that's the rub, isn't it...? The economy is hanging by a very thin thread, indeed.

Can the other sectors of the economy make up for the present and upcoming decline in personal spending on goods and services? Let's see..
  • Private investment: are businesses going to go on an investment spree soon? Highly unlikely - with unemployment rising and demand for all goods and services slackening businesses are going to be playing defence for a long time to come. And quite obviously individuals are not going to be buying new houses in great numbers, either.
  • Exports: unless the dollar slides very, very substantially exports are not going to be a driver for the real economy. Yes, the trade deficit may shrink further due to a drop in imports and thus affect GDP accounting, but that doesn't change things.
  • Government spending: This is the wild card- or joker, if you prefer. A massive Keynesian intervention is always a possibility, theoretically. But, in the real world... with what money? The government is already facing a $1+ trillion dollar budget deficit this year, having foolishly spent a boatload of money on ill-considered bailouts. Can it keep borrowing even more from the Chinese, et. al.? I don't think so..
Bottom line: We are now entering Phase B of the recession (it is better described as a depression, with a small "d"). We are likely to see sustainable declines in personal consumption for several quarters, since unemployment is high and still rising, crimping earned income. I very much doubt that banks will go on a lending spree to households to support spending - in fact, I believe they can't, given the atrocious shape of their balance sheets.

After the current transition period in GDP figures, which is characterized by a stabilization in business spending and inventories, I am looking for a series of quarters of -2% to -3% GDP declines, almost all of it from consecutive declines in consumer spending, particularly in services.

Once again, I note that all figures are nominal, i.e. not inflation adjusted.


  1. Awesome break down. Thanks

  2. This is fascinating--thanks. It seems that companies are much better than individuals at recognizing that they need to cut back; it seems that every company I analyze has had falling sales but kept income/cash flow roughly steady by cutting costs/capital expenditures. For all the chatter about "the consumer cutting back" it really has only begun to happen recently, as evidenced by the growing GDP numbers on consumption from 2006-2009. I suppose this makes sense since companies are run by MBA's with spreadsheets, but families (in the aggregate) don't cut back until they have no other choice, and also usually don't have a good detailed picture of their personal finances outside of immediate cash flow.

    I would like to quibble with your statement at the end of your piece--that the condition of a bank's balance sheet determines whether it will extend credit. Contrary to accepted teaching, it appears that banks make loans and then find funding for them. The driving factor is whether the borrower is creditworthy or can offer collateral or if the bank can pawn the loan off on someone else--or some combination thereof. I hate to say it, but in some areas like housing, it requires only consumer will to get the lending machine going again, since the FHA appears willing to make no-down payment loans (OK, 3%, what's the difference) to all and sundry.

    Turn the machines back on!! Mortimer, tell them to turn the machines back on!!!

  3. Very helpful, thanks

    I know there are some areas- like video conferencing- that are absolutely exploding. A friend of mine is video conferencing installer and he says sale's of Norway's Tandberg products are on fire right now.

    Indeed, most of the public high schools/middle schools in the area are setting up video conferencing systems in case swine flu gets much worse (it is pretty bad right now).

    I would think this would have a bigger impact on oil imports than than anything else and be a net positive to the US economy (bad for the middle east).

  4. So why is the market up 50%? Government stimulus and continued consumer spending while companies cut costs and employment to buoy the bottom line.

    What will crack confidence here? Swine flu? Failed US bond auction?


  5. The DOW is in a wave 4 rally that is now peaking at 38% retracement. Wave 5down is at hand and will be a dousy. Probably will take the DOW to 3000.

    This might even wake up the grazing sheep.

    Joe M.

  6. I can't help thinking that there are hidden assumptions in these ideas about personal spending, and that these assumptions turn on the idea that the American consumer is running out and buying, buying on spending sprees at the local shopping mall. (Yeah, I'm being inconsistent, I know...)
    Okie's not too recent link showed us that most consumer spending is on incompressible items like : mortgage, health insurance, education, and that the middle class is in danger due to mushrooming costs over a relatively long period.
    So.... just what is going to compress these costs ? And if people don't have jobs, then there IS NO economy, at least from a personal spending standpoint, is there ?
    My point being... how do you cut back when you're ALREADY hanging by a thread ?
    Unless we all start our own vegetable gardens, and stop eating meat, for example...(But what would we do with all those cows, and the meat industry would be REALLY unhappy, sigh...)
    Of course... one way to cut back would be to ensure a major societal reorganization by... getting people (whichever sex) back into the home, instead of OUT of it.

  7. Do Americans really spend three times as much on financial services as on transport? Or do these numbers mean Americans barely leave the house without a car?
    Here in Holland sales of electrically enhanced bicycles were up 40% last year. Perhaps these could increase in the US too.
    See, for example


  8. Nice work. You always seem to bring an additional, unique perspective to the table. Thank You!

  9. Congrats on a really well-written post! A logical sequence of evidence supporting and explaining your theory...the MSM will greatly need to step up its quality if it expects to compete in the future with blogs like this.

    I can imagine some perpetually positive people saying "its not that bad of a decrease", but I would have to point out your statement that much depends on foreigners continuing to lend us money to fuel our deficit spending. Seems unlikely.

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  11. I have the pleasure of writing this from the great state of Montana, where I am spending a month researching at the University of Montana.

    I do have a question regarding how is the current US debt being financed: I've read somewhere that is is not China (and Japan...) currently buying treasuries. But it would be primary dealers with borrowed money from the Fed.

    I don't know if there is any truth to this, but if there is, isn't this nothing more then printing money (while primary dealers get a nice commission from the spread from fed cheap money to treasuries)?

    The fed prints, the govt borrows the printed money...

    If this is the case then the printing press would be financing the real economy....

    If this is the case, the eternal question of hyperinflation because of lack of trust (as there would be trillions of USD being printed and used) would return?

    Or maybe it is still Asians buying Western debt and all is still status quo...

  12. What an excellent post! This is the first time I have seen the 70% 'consumer spending' cohort further dissected into its component parts. Add significant consumer credit contraction, 30% apr credit card rates starting on October 1st, continued unemployment and downsizing and Phase B down will be a bad one.

  13. Superb analysis. If politically possible (a big "if"), is there a second stimulus package around the corner? If the healthcare segment doesn't see growth, could it be assumed that those monies are being saved by consumers and possibly be being spent in other segments?

  14. Great post, Hell.

    Someone asked the following question:

    "So why is the market up 50%?"

    The stock market, for what might be described as indefinite periods of time, mostly due to "liquidity flows"- and there has been a lot of liquidity flowing of late to a select number of Wall Street institutions - can behave in a manner that makes it appear as if the share market is utterly detached from the state of the economy as a whole.

    It isn't, but we have had unprecedented sums of (our) money handed over to financial institutions that can not and will not lend. So, where does all that filthy lucre go? Well, those lucky recipients can (as part of what is an agreed upon beforehand scam, uh, scheme) park the money in government paper-because Uncle Sam has enormous funding requirements these days- or, they can speculate in the stock market.

    They are doing both.

    And guess what? The greatest share volume by far during the rally, especially of late, has been in those same zombie financial institutions that looted all the money via the various banker bailout programs.

    In fact, for some number of weeks in August, just four stocks accounted for as much as 40% of composite volume on the NYSE: Citigroup, Bank of America (BAC), Freddie Mac (FRE) and Fannie Mae (FNM).

    My how things have changed from
    early 2007, when Citigroup, Fannie Mae and Freddie Mac accounted for a mere 1% -3% of NYSE volume, a far cry from its recent 35%+ collective weight of the composite NYSE volume.

    Get the picture?

  15. Very good post Hell and I completely agree. This kind of superb analysis is what brings me back to your blog again and again, even though I cut down on many other previously favorite blogs.

  16. I've always wondered why services seem immune to all this. Thank you for the wonderful insights.

  17. Some questions on this analysis :
    I am very very intrigued by the category "other", particulary since it is a relatively big wild card, with 14 % in there. Is education involved, somehow ?
    Evaluations about what is necessary, and what is not, are intensely subjective.
    I think that we have not been collectively reflecting enough on the possible reasons behind our moving from a highly material, and materialized economy to a more and more abstract one, in the form of services. This move, in my book, can best be looked at from a...philosophical/psychological framework, not a strictly economic one.
    We need to explore the reasons behind this, at least at the same time we try tinkering with the hardware, plumbing to try fixing.

  18. Hell, I have a question re: my old friend cooperation and that tragedy of the commons..

    Is it possible central banks from different countries would ever come to agreements whereby country A would buy a ton of country B's treasuries while country B would purchase an equal amount of country A’s treasuries?

    In effect, if the purchases were equivalent and things went bad, neither country would have transferred wealth to each other but they would have helped each other create inflation without “snoops” thinking individual treasuries were printing money.

    If such a scenario of cooperation occurred, wouldn't it be invisible unless worldwide data showed that aggregate world governmental purchase of treasuries was way up.

    I notice the the White house hired Brad Stetser so I have lost my educator- I don't mean to suggest the conspiracy theories some often do.

    How does one tell whether national treasury demand is from non-governmental or governmental sources? And how does one link this with data with every other country (or is this done somewhere easily already?)

  19. Re Treasuries

    Buying each other's debt is a net wash, of course.. and it accomplishes nothing.

    The major problem is that the US is faced with a monumental budget deficit ($1 trillion+) and NEEDS to induce both domestic and foreign investors to purchase its debt, regardless of any additional hanky-panky swaps that you allude to.

  20. Hell wrote:

    "The major problem is that the US is faced with a monumental budget deficit ($1 trillion+) and NEEDS to induce both domestic and foreign investors to purchase its debt, regardless of any additional hanky-panky swaps that you allude to."

    I would argue that the problem is actually quite different and more intractable than luring recalcitrant foreigners or locals to step up and buy sovereign debt.

    The problem is that the marginal utility of aggregate debt has very likely passed the zero point such that taking on any more debt is now counterproductive. This view is controversial from the standpoint that one can question whether the zero point has been reached, let alone surpassed. I operate on the notion that it has, at the least, been reached.

    With that in mind as an operating principle, U.S. currency and sovereign debt are presently in much the same position of Wile E. Coyote immediately after running off the edge of the cliff. For those who don't recall, there was a brief period of seemingly miraculous levitation (courtesy of the magic of animation) that soon gave way to the implacable forces of gravity.

  21. Regarding Treasuries,

    I think you are discounting the psychological and social value of money.

    Being able to issue money and then use it to buy your debt through indirect ways CAN get you a long way as long people dont perceive that as making the paper you issue worthless.

    This is why I think the hyperinflation argument has some ground: people might see so many USD (or GBP or EUR) being printed (and indirectly used to fuel debt) that they start perceiving printed money paper as worthless.

    Money is MORE of psychological value than of "real" value. If the psychological value breaks, hyperinflation is a possible scenario.

  22. Thanks and sorry, I meant in terms of printing.

    Is there a way America (and/or other countries) can simultaneously print in a way that

    1. Does not upset international creditors
    2. Occurs under the radar of the market?

    There is always this talk about competitive currency devaluation; I was thinking more along the lines of cooperative currency devaluation?

    And one last question (for anyone) on slicing and dicing the debt and what it all means.

    I am sure you all heard the following joke:

    It is a slow day in the East Texas town of Madisonville. It is raining, and the little town looks totally deserted. Times are tough, everybody is in debt and everybody lives on credit. On this particular day a rich tourist from the East is driving through town. He enters the only hotel in the sleepy town and lays a $100 bill on the desk stating he wants to inspect the rooms upstairs in order to pick one to spend the night. As soon as the man walks up the stairs, the hotel proprietor takes the hundred dollar bill and runs next door to pay his debt to the butcher.

    The butcher takes the $100 and runs down the street to pay his debt to the pig farmer. The pig farmer then takes the $100 and heads off to pay his debt to the supplier of feed and fuel. The guy at the Farmer’s Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has lately had to offer her “services” on credit. The hooker runs to the hotel and pays off her debt with the $100 to the hotel proprietor, paying for the rooms that she had rented when she brought clients to that establishment. The hotel proprietor then lays the $100 bill back on the counter so the rich traveler will not suspect anything.

    At that moment the traveler from the East walks back down the stairs, after inspecting the rooms. He picks up the $100 bill and states that the rooms are not satisfactory…… Pockets the money and walks out the door and leaves town. No one earned anything. However the whole town is now out of debt, and looks to the future with a lot of optimism.

    Debt itself must be very non-linear, no?

    There must be a few in a ton of debt who owe their debt to people who are also in a ton of debt. But others with little debt and those they owe also have little debt.

    e.g. vegetarians probably still eat fewer Krispy Kremes than non-vegetarians even if they are fried in vegetable oil.

    If you were to subtract out the non-linear prevalence of debt amongst people AND the non-linear nature of who they owe the debt to, would things look a lot worse for a few but a lot better for many?

    Or would things not change very much?

    Or would they be even worse for many but better for a few?

  23. I agree Thai, it is indeed, especially where fiat currencies are concerned, a confidence game. I think that's what you've asserted in so many words.

    And when confidence in a currency passes some difficult (but not impossible) to define critical threshold, hyperinflation ceases to be what it is the vast majority of the time, namely a remote possibility, and instead becomes an inevitability.

  24. Dear Thai,

    If debt was indeed structured the "Madisonville" way things would be extremely easy to settle. What is described in the joke is, in fact, a barter economy, not a modern debt and currency economy.

    To make only one point: think who we "owe" money to - banks. And banks, among other things, act as a funnel for those with large pools of capital.

    In the modern Madisonville debt is OWED by most, but OWNED by very few (ah, fractals..).


  25. LOL!!!!

    I always find the hardest part about not understanding some things is when I realize it is because I don't know something but that I don't know what I don't know.

    Anyway, I really do want to convey a sincere "thanks" for taking the time to help those of us in the back of the class as well. I am sure I speak for many people when I say this.

  26. Very interesting.
    I am WAY BACK in the classroom. I STILL don't think that I understand...

  27. It appears that the unemployment curve has reached a plateau and may not be rising as steeply as before if at all. This has led many to advocate that the worst is either here or near, and that the employment rate recovery would be gradual as historical evidences have shown.

    In my view, Phase B would most likely be a period where asset deflation has reached the bottom thus making it attractive; both in terms of annualized returns and asset capital appreciation, for private but mostly foreign investors to start acquiring them. This influx of capital would also be the post-effect of the trillions of dollars in stimulus packages already cumulating in the global markets. When these excesses ripple down to the hands of the retail investors, the likelihood of the private investment component posting gains again would be real. Investors are already scouting for viable businesses/investments in countries like China, Hong Kong and S E Asia and the next target could be Australia, UK and US or even the Middle-East.

    This scenario is likely to occur in the US when investors are convinced they are witnessing a bottom coupled with the realization of a coordinated return of market confidence which the stock market is experiencing in recent months. Greenspan is probably correct when he said that greed is a human virtue and is infectious.

    So the crux of the recovery may not lie in consumer services but in private investment after all since it would lead to job creation and stability thus sustaining personal consumption.

    It is interesting to note that government spending has effectively made up for the drop in private investment to maintain personal consumption. I would like to see how this is achieved even if some may think that it is unsustainable.

  28. Great article. I stumbled across it while I was research increasing trends in our search logs at . We have seen a steady increase in debt related questions. We were a little surprised that the topic seems to keep increasing in activity rather than flatten out or marginally decline. Anyway, it's anecdotal evidence but does directionally support the post here.

  29. I am sure Hell is grinning from ear to ear right now.

    I assume everyone else understands the significance of someone from a search engine firm making this comment?

    Kristen, are you in the theory wing of your search engine firm?

    If so, then you may understand my two questions:

    A. What are the contexts and aspects of the framing of the debt queries that are growing most rapidly?

    B. What framing aspects of the queries are you finding most surprising?

    Anything you can share would be most appreciated


  30. LOL!!!

    Marcus, you can call me a fool today as I think I just got fooled by a spider-bot.

    Does that count as a touring test?