Credit Crunch Causes Drop in Consumer Spending

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All this has been obvious to us for a long time. Still, until this summer, nothing gave. Consumer spending continued to rise!

But now, the latest news is that consumers are finally slacking off. Auto sales are plummeting, for example.

Of course, the first thing to go was spending on houses itself. The builders got nailed. And then, the people who financed the builders…and who lent mortgage money to borrowers who couldn’t pay it back. But nobody seemed to care…until the ‘radioactive paper’ – derivatives based on mortgage debt – started to melt down. All of a sudden, a ‘Credit Crunch ’ was in the headlines…and Wall Street was on the phone to central bankers.At first, hardly anyone knew what a credit crunch was. People thought it was a new breakfast cereal. The newspapers had a problem with the story from the get-go. They didn’t know whether it should run in the finance section…or the Police Blotter. Subprime lending could have been a crime story…or a financial accident; they didn’t know.

Then, the banks began to announce losses…and the numbers grew. A hundred billion here…a hundred billion there…pretty soon, we were talking about real money.The latest estimate comes from Goldman Sachs (NYSE:GS). Goldman says total losses from subprime lending will hit US$400 billion. But the golden boys go on to say that the losses to the economy will rise to US$2 trillion. Ah, yes, dear reader. That is how a credit crunch works. When credit is expanding, a relatively small amount of money is leveraged into a big amount of money. A borrower might use US$100 million deposit, for example, to anchor a loan for US$1 billion. But when credit contracts, leverage works in the opposite direction. A hundred million of capital disappears…and the US$1 billion of loans are withdrawn. Altogether, Goldman expects US$2 trillion in cash and credit to evaporate.This is bad news for the US consumer…and for the people who sell him things.

Already, there is “alarm at rising US car loan defaults,” says the Financial Times. And gasoline in the United States rose 13 cents in the last 2 weeks.And, remember…the consumer has to eat! Food prices have been going up five times faster than the reported CPI.Give them enough time and even economists can put two and two together. Now, more and more of them are predicting a recession. And everyone has his eyes on the holiday sales figures. But…and here is a fairly big but…a Texas-sized but, in fact: so far, the stock market has edged down…but it has not crashed. Our ‘Crash Alert’ flag is still flying. And we’ve had some exciting 300+ point declines. Just yesterday, the Dow went down more than 200 points. But no crash.

You’d think investors would want to get out. You’d think they’d at least want to watch what happened from the sidelines for a few weeks. But so far, we’ve seen only a steady retreat…no panic. No crash. No collapse.

The old market hands are wondering…what does the market see? How come it doesn’t correct in a major way? Do investors really think that the declining dollar will save them…? Are they expecting another big rate cut from the Fed (Bloomberg says another 3/4 point is coming…)? Do they think it will all blow over…instead of blowing up?

More tomorrow…and the day after…and the day after…

Bill Bonner
The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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Comments

  1. Bill:

    Reckon Paulson’s Plunge Protection Team has been working overtime on the market lo these many days, just long enough for Goldman Sachs to short….

    Yeah I think there will be more cuts from the Fed – what else can they do? The only thing that has a ghost of a chance of giving them any global credibility is to *raise* rates, and that would take a real pair of big brass ones considering the long line of Wall Street villagers with torches and pitchforks that would follow.

    Let’s just say that Helicopter Ben is no Paul Volcker.

    Reply
  2. Can we really believe that inflation is as low as ABS figures suggest?

    An issue that could be worth raising while the election is still on is whether we really should take the ABS’s inflation figures seriously. To many ordinary Australians the actual inflation rate they perceive when the go shopping seems to be significantly higher than the numbers regularly published by the ABS and some background research suggests that maybe the average person might be right.

    In recent years, the ABS has been changing the way it measures inflation to follow recommendations made by a US Commission commonly referred to as the ‘Boskin Commission’. That Commission was set up in 1996 with the undisguised objective of making recommendations that would reduce the measured US CPI (the US inflation rate) because a majority of politicians were concerned about US government’s committed expenditures on Social Security and as these payments are indexed to CPI. Reducing ‘measured’ inflation was considered a really neat way of reducing future social security payments. Most of the ordinary population were and are unaware of the changes that were made which makes it even better for the politicians!

    In the US, amongst those that knew, including economists, the validity and need for these changes was controversial. Nevertheless, the changes were and are continuing to be implemented.

    The Commission said that if their recommended changes, which mostly involved the treatment of quality and new products in the measurement of CPI, were implemented the ‘measured’ US CPI would be about 1.1 percentage points lower (maybe even 1.6 percent lower) than if the unchanged approach continued to be used.

    The ABS started implementing these recommendations in 1999. The cumulative effect of the changes, that is the difference between the price level if the old method was continuing to be used and the price level with the new approach could by now be quite substantial. Also, anyone in Aus with income indexed to the ABS’s CPI could be getting a lot less today as a result of these changes.

    So the question is, which should be raised during this election period,can we believe the ABS’s numbers? Is inflation really as low as they suggest? And what role has the current government had in having the changes implemented? Of course, a lower ‘measured’ inflation rate does make the incumbents look better.

    The measurement of inflation has important implications as many people receive income from sources indexed to the CPI. And the CPI is an important point of reference when workers negotiate wage rates with their employers.

    X

    Here are some reference so you can check this out.

    http://www.princeton.edu/~deaton/downloads/letterfromamerica_oct1997.html

    http://www.ssa.gov/history/reports/boskinrpt.html

    http://en.wikipedia.org/wiki/Boskin_Commission

    http://thomaspalley.com/docs/articles/macro_policy/rewrite_economic_history.pdf

    http://www.prospect.org/cs/articles?article=the_inflated_case_against_the_cpi

    http://www.shadowstats.com/cgi-bin/sgs?

    Reply
  3. As an ex public servant – the bulk on my PSS super balance (being indexed to the CPI) is losing purchasing power and will continue to do so for the next decade at least. The scheme is absolute crap and I have no idea where the market linked compent of this investment stands.

    Coffee Addict
    November 23, 2007
    Reply

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