The household balance sheet remains the primary concern with regards to the economic recovery. The latest data from the Federal Reserve on consumer credit showed the first expansion in credit in 12 months. While many view this as a positive I remain skeptical of the sustainability of the recovery. Total consumer credit expanded to $2.46T in January. Unfortunately, this is exactly what the consumer shouldn’t be doing right now and substantially increases the risk of a stimulus withdrawal resulting in a double dip in 2011 or 2012. At the same time we are beginning to see signs of life in consumer sales – another potentially negative omen for the wobbly recovery. While all of this might appear to be a positive at first glance it substantially increases the risk of a double dip. Allow me to elaborate.
Fitch recently reported that the charge-off rate for prime credit cards remains at its highs:
Fitch Ratings-New York-03 March 2010: U.S. credit card charge-offs surged to near record levels set last fall, according to the latest Credit Card Index results from Fitch Ratings.
Fitch’s prime credit card charge-off index jumped 112 basis points (11%) to 11.37%. The results, which cover the January collection period, pushed the index to its highest level since September 2009’s record 11.52% and 54% above year earlier levels. The increase was largely driven by a payment holiday for Chase credit cardholders, which pushed more charge-offs into the current period .
This highlights the continuing debt woes in the private sector (specifically consumers). As we’ve long maintained, it is this perpetual expansion in consumer debt which not only caused the credit crisis, but could ultimately result in its nasty revival. As Fitch notes, these trends are likely to continue barring some miracle return in jobs growth:
“Late-stage delinquencies are still trending in the 4% range industrywide, which is keeping chargeoff levels in the double-digits,’ said Managing Director Michael Dean. ‘Until we see some meaningful improvement for employment numbers, consumer delinquencies and defaults will remain elevated at or near these levels.”
Remember, we’ve lost over 7 million jobs during this recession. If the jobs recovery were similar to the 2003 employment recovery it would take until 2016 to get back to the pre-credit crisis employment levels.
What’s so interesting in all of this is the potential for a consumer led double dip in 2011 or 2012 if the government steps aside and the stimulus programs end. As the following chart shows, you can easily see that American households have simply spent more than they earn over the last 6 years. Ignore every single one of those parabolic (fear mongering) debt charts you have seen all over the internet and in research reports that attempt to show how scary the U.S. government’s mounting debt woes are (remember, as the sovereign issuer of the currency, THE UNITED STATES CANNOT DEFAULT ON ITS OBLIGATIONS! – see here & an explanation of the continuing deflation threat here). But households certainly can default and do so every day.
What’s crystal clear over the preceding 12 months is that the government stimulus has attributed for the majority of the economic rebound. The hope, of course, is that the public sector will soon hand over the baton to the private sector. I fear that is not a transition that can occur just yet. According to my calculations the $1.4T gap between what households earn and household liabilities will continue to be a strain on households for approximately TWO more years. This assumes no major structural changes in the economy or the housing market (which I actually expect to further weaken barring even more stimulus). Households need to continue de-leveraging in order to repair their balance sheet back to a time when their incomes are in-line with what they spend.
Of course, a continuing culprit in all of this is the banks. This industry which takes much and produces little, continues to hurt the potential economic recovery with their debt based revenue model. This is not to imply that the U.S. consumer played no role in taking out more debt than they should have, but the lack of regulation in the banking industry substantially contributed to the gross amount of debt that consumers (and banks) have been allowed to take on (no doc, no down loans come to mind here). The United States government absolutely must pass harsh regulation on these banks and prohibit them from ever being able to fool the consumer into taking on so much debt (or leveraging up their own balance sheets with reckless products). At the same time, U.S. consumers must wise up, continue to fix their balance sheets and make prudent and educated financial decisions.
The latest data from the Fed on consumer credit shows that the days of saving and financial prudence may have been short-lived. If the consumer continues to take on more debt than their income we will continue to see a very weak economic recovery. And if the government attempts to pass on the baton by falsely assuming that the consumer can run with it, then we are at very serious risk of a double dip in 2011 or 2012.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.