Consumer Retrenchment Cause for Deflation

First and foremost is the dramatic switch by consumers from a 25-year borrowing and spending binge to a saving spree that should extend a decade or more. In the 1980s and 1990s, consumers regarded their soaring stock portfolios as continually filling piggybanks that would fund their kids' education, early retirements and a few round-the-world cruises in between. So they slashed their saving rate and pushed up their borrowing to fund spending growth that consistently exceeded the rise in after-tax income. When stocks nosedived with the collapse in the Dot Com bubble in 2000-2002, leaping house prices seamlessly took over to finance oversized consumer spending growth.

But now stock and house prices -- the vast majority of most consumers' net worth -- are not only depressed but also unlikely to revive to their former glory days for many, many years. Furthermore, there are no other major consumer assets that could be borrowed against. So consumers are being forced to embark on the saving spree.
Household debt as a percentage of disposable income hit a low of about 2% just at the end of WWII. It's been going up ever since. By 2005 it nudged against 15% - seven times higher than it had been 60 years earlier. Household debt represents spending that has been taken from the future. But it is not possible to take an infinite amount from future earnings.
For the next decade, an average 10% saving rate annually, is likely raising to over 12%. Even a decade of vigorous saving will probably not return household net worth close to its former peaks or eliminate completely the three decades of ever-increasing household financial leverage.

Paying down debt will obviously have negative ramifications for the real economy. Many small businesses that depend on outside financing are starving as banks tighten lending standards and consumers stop buying their products.

Consumers embarking on a saving spree will no longer be the buyer of first and last resort for the globe's excess goods and services. Furthermore, with slower global growth for years ahead, virtually every country will be promoting exports to spur domestic activity. When every country wants to export and none want to import, the pressure for protectionism will increase.

Chronic deflation will be the result reducing growth in the next decade or so. Years of rebates and now stimulus packages as cash for clunkers have for example trained car buyers to expect continuing and even bigger discounts. So they wait to buy. That leads to excess inventories that require even larger price concessions. Buyer-suspicions are confirmed so they wait longer promoting more inventory buildup, more price cuts, etc. in a self-feeding cycle, an effect, of course, that retards spending and is further slowing economic growth.

With consumer retrenchment and a shrinking pool of global imports, export-dependent lands will be competing even more fiercely for the remaining markets. Resulting in fewer man-hours that are needed to produce goods and services. Putting another pressure on continuing joblessness. Over the last 10 years almost no jobs have been added to the private sector. Employment is back to levels of 1999. There are more jobs in restaurants and health care, but many fewer in manufacturing.

The only job gains have been in the ‘parasite’ none productive sector of government. On the evidence, this trend is going to continue. Now, the feds have a new post called "pay czar." As near as can be seen this is a busybody who undertakes to control salaries in the industries such like the banks, GM and Chrysler that the feds have bailed out.

Back in the private sector, 72 banks have failed so far this year. And a record 34 million Americans are getting food stamps.

Consequently, incomes are falling. Now, imagine the consumer...he's already paying 15% of his disposable income to debt service...and then his income is cut in half! This means that 30% of his remaining income must be used just to service the debt. Impossible to do without big cuts in spending.

The poor consumer hit the wall in 2007. He was spending all he earned, and paying more of his income in debt service than at any time in the last 60 years. He couldn't continue to living on future earnings - there just weren't enough of them. That is why the finance industry has topped out. It loaded Americans up with enough debt already.

In the Great Depression of the 1930s demand was pushed well below supply. Japan also suffered such deflation over the last two decades after the collapse of her 1980s housing and stock market bubbles. But in Japan, the lack of demand wasn't caused by a dearth of employment and income as in the U.S. in the 1930s, but because the government delayed cleaning up her financial institutions while consumers refused to spend their incomes.

Present excessive monetary and fiscal stimuli are key reason for chronic and severe inflation in future years. However surplus inventories being the result of producers, wholesalers and retailers caught unaware when consumers suddenly retrenched last fall have still to be sold off and are depressing prices in the process.

Wage cuts and mandatory furloughs for the first time since the 1930s, as well as layoffs are obviously deflationary as they depress purchasing power. In addition, the excess of supply over demand has clearly implications for deflation.

If the private sector undertook to reduce debt back to 2000 levels, it would mean eliminating all the debt accumulated during the bubble years - or about $19 trillion. How long will it take to pay down, write off, inflate away and otherwise shuck $19 trillion? Well, inflation is running below zero - so that is not now a source of debt reduction. Between write-offs and pay-downs, about $2 trillion has already been cut - over, very roughly, the last 2 years. At least the math is easy. At that rate, it will take 19 years.

Nevertheless, in the end inflation is inevitable in the long run. All the money being pumped out by the Fed and the Treasury deficits is sure to stimulate too much demand in relation to supply, when a new equilibrium between supply and demand is reached. But before money can promote excess demand, it's got to get into circulation, and scared lenders and creditworthy borrowers are unlikely to convert massive bank reserves into money until rapid economic growth resumes. And that is unlikely for many years.