Consumers’ Change of Heart

The vast credit expansion that lasted from 1945-2007 now has contracted till an insignificant quantity, as people’s hearts and minds have been thrown into reverse.
 
During the bubble years, more and more credit produced less and less real prosperity. In 2005, Americans saved nothing. Now, the savings rate is over 5% of disposable income, an enormous turnaround.
 
Saving money by not spending it makes people wealthier. Saving money creates capital. And capital accumulation invested in factories, roads, ships, buildings, machines offers people the ability to produce more. It may take a man with a shovel a whole day to dig a decent hole. Give him capital to invest in an excavator – and he can in the same time dig a hole large enough to build an underground parking lot for tens of cars. That's why capitalism works. It rewards the one who saves his money.
 
If households don't consume, the consumer economy won’t grow. In fact an economy won’t grow by borrowing money and spending it on consumables. That was the case in the last half of this decennium, despite the biggest increase of borrowing and spending in history, the consumer economy barely grew at all.
 
"In the five years to December 2007," reports Grant's Interest Rate Observer, "America's credit market debt climbed by nearly 57%, to $18 trillion. However, in the same half-decade, nominal GDP was up by only $3.3 trillion."
 
Simpler explained: for every five dollars consumers borrowed, they only increased their incomes by $1. Imagine that the borrowing had an average effective interest rate of 10% (credit card debt can be much more expensive). At that rate half of the additional income earned between 2002 and 2007 had to be used just to pay for the interest on the loan.
 
This was not the kind of growth that was likely to last. In fact, it didn't.
The whole market came crashing down in '07 and '08. Meanwhile, the consumer had a change of heart and decided to stop with borrowing.
"The ratio of cash held by households as compared with assets has been rising sharply," says an article in The New York Times.
 
"Companies, households and banks all want to pay down debt and prefer to hold cash rather than assets, partly because the outlook for those assets is poor and partly because after a decade of excess, everyone feels over-extended.”
 
"This is exactly what happened in Japan during its lost decade, when a balance sheet recession, one characterized by the paying down of debt and liquidations of assets, was self-reinforcing and very difficult to stem."

American consumers must have added about $7 trillion in extra debt during the Bubble era of 2002-2007. Now, instead of buying things, people use their money to pay it down. The average household has about $43,000 worth of income. Let's keep the math simple by saying there are 100 million households in the United States, and that they save 5% of their income. When every penny of savings is used to pay down debt, it will take about 30 years to pay the debt off!
Meaning this recession will take that much time before the financial collapse is over.

Take a look at Japan by now two decenia in recession and deflation:

In the late 1980s Japan was busy buying up American companies at a breakneck pace. They too felt pretty rich. And were sure that they were out to conquer the world.
By 1989 their market went through its own credit meltdown, like the one recently occurred globally, but on a smaller scale.

However Japan still has not recovered. Not just economically, with a stock market that's basically flat-lined for the last two decades, but culturally too. Already high Japanese savings rates exploded. Resulting in 50% lower car sales, cabbage long ago replaced meat on Tokyo dinner tables. The middle class Japanese started washing their clothes in used bathwater. Are these Japanese impoverished?
No. These are well-employed Japanese middle class. With good jobs and incomes, but working and saving as though they could lose everything all over again.

What will happen if the same consumer malaise locks into place in the rest of the industrialized world? It will cause a much longer recession or even financial depression than anybody is willing to imagine, at this moment.

Nonetheless there are ample signs that this is exactly the radical shift that now is underway. The world is waking up to a very scary realization. All those big houses recently bought, the cars and fancy techno gadgets, the fancy clothes and furniture, the $100 dinners and $5,000 vacations, are suddenly things of the past.

People today are facing an economy in which 70% of the economic output depends on consumer buying, on the contrary no buyers, no recovery.

And yet, unlike the previous minor busts and even major corrections, the lesson hundreds of millions of strapped people are learning all over again is that same lesson our ancestors learned after 1929.

Namely, that the law of personal and financial responsibility is as irreversible as the law of gravity. A condition no politician, leader, no matter how popular with multi-billion dollar bailouts, regardless how large, can transform.

As stated in the first sentence of this article: the hearts and minds of the consumers have changed and been thrown into reverse. And it's this total psychological "impulse" that will make a back-to-baseline conventional recovery impossible any time soon. Count with 10 years if all bailout money immediately are stopped and reversed, but if not as very much is likely, it will be 20 or even 30 more years.

Explanation to attached inverted pyramid:
This inverted pyramid shows how the debt-based monetary system is constructed.
“The U.S. and world economies are on the threshold of a deflationary crash that will make the 1930s look like a boom. Gold will be the single best investment to own. Buy it now while it’s still cheap.”
The debt pyramid -“The great Credit Contraction”- is attached to this article to show that the broadest and most unstable “asset” class is the derivatives at the top. This is what is causing the current worldwide financial adjustment as the central banks continue to assure the markets that everything is going to be just fine, and they pump “money/credit” into the system until … it eventually will collapse!!!!
Source: Financial Sense Editorials

In the dual demand destruction spiral are the compounding financial factors graphically explained.

Note:
Credit Contraction is a sudden reduction in the availability or use of loans as well as other types of credit from banks and capital markets at given interest rates. The reduced availability or use of credit can result from many factors, no demand from borrowers, including an increased perception of risk on the part of lenders, a broad consumer awareness to avoid borrowing, an imposition of credit controls, or a sharp restriction of the money supply.