/ 23 November 2010

Clinging to consumerism

Bernanke says the US is not a patient country - which is the US in a nutshell

If you are trying to understand exactly what is going on this crazy world of economics and finance, it is worth listening to Kevin Lings, the economist for Stanlib, if you get a chance.

He has the ability to cut through the complicated jargon and explain in basic terms what exactly is going on. The problem is that after listening to him and understanding exactly what is going on, you feel a lot less optimistic.

Basically the US is not facing the reality that the world as they know it has changed forever. The politicians and the voters do not want to admit that an economy driven by consumer spending (70% of economic growth comes from shopping) is not sustainable.

Rather than taking the pain of a structural change to the economy which will see consumers playing less of a role, the Federal Reserve is pumping money into the system to encourage people to shop.

The problem is that US consumers don’t want to shop. They are scared, worried and they want to get rid of the debt that has destroyed their lives. It seems the consumers here are being more rational than the government.

The problem however is that if consumers don’t start spending the US consumer-driven economy will not be able to re-hire the 7,4-million people who have lost their jobs and politicians will lose theirs.

In fact the US needs to create 13-million jobs not only to re-hire those who lost theirs but to absorb the estimated 100 000 new job seekers which enter the economy each month.

Lings tells a story about an exchange at the recent International Monetary Fund (IMF) conference. A European central banker was urging the US to have patience — “you have done everything you can, eventually everything will work out. After all the US has had five quarters of positive economic growth and house prices have stabilised and one million jobs have been created.

Bernanke (head of the US Federal Reserve) simply replied that the US is not a patient country — they want results now and 2,6% growth is not good enough, at this rate it will take too long to create those 13-million jobs. This means the US will do everything in its considerable power to kick start its economy.

Lings says this is not just a matter of cultural difference, but the very real fact that the US does not offer the same safety net for unemployed people that Europe does.

In the US unemployment benefits run out after 26 weeks. If the person has not found a job by then they are left destitute — their American dream is over. Europe, with its social welfare system will not feel the impact of angry unemployed citizens as keenly (although Europe has its own set of problems in having to cut back on its social welfare programmes).

Lings explains that quantitative easing” which is a fancy word for throwing $600-billion into the economy, is a last resort. The US government has already tried lowering interest rates, increasing government spending, tax incentives and bailing out the motor industry. There is not much left for it to do but literally give money away.

The mechanism of this quantitative easing will see the US Fed buying US government bonds with money balances that it has created. This not only puts $600-billion into the economy but also helps keep US bond yields low. This will keep mortgage rates low as they are priced against the US 10-year treasury bonds.

While the Fed is not literally printing money (it is expensive to buy the paper and ink) it is just creating an electronic transfer with lots of dollars from non-existent sources. It sort of like adding a couple of zero’s to your bank statement. Imagine having that kind of power?

The problem so far is that all the money it is creating is either sitting with the banks earning 0,25% interest as no-one wants to borrow money (the excess banking reserves have grown from $0 in 2007 to $1-trillion today) or flowing into emerging markets which is why the rand is flying so high.

Corporates are also sitting on cash, corporate cash balances are currently the highest in history. They are not expanding or employing.

Lings says what is needed now is confidence. If there is confidence by consumers to start spending and corporates are confident consumers will spend, then the economy will ignite pretty quickly. But right now there is no confidence, and perhaps for good reason.

But one still wonders even if the consumer does start spending, where will the US be in ten years time if it doesn’t address the real issues around the balances within its economy.

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