international analysis and commentary

America’s indebted recovery


Five years after the collapse of investment bank Lehman Brothers and the beginning of the global financial crisis, the economic recovery in the US remains fragile. Except for the Federal Reserve, however, nobody seems ready to step in and prop it up. The US government has taken itself out of the race by means of political paralysis. Households are still cautious after seeing much of their previously accumulated wealth evaporate in the back-to-back crashes of the real estate and financial markets. Caught in the middle, American corporations are also hesitant to bet on a strong performance, and are hoarding cash instead of investing. Unsurprisingly, the International Monetary Fund recently cut its 2014 growth forecast for the US by 0.2%, to a meager 2.6%.

Estimates of the cost of the sixteen-day government shutdown that ended on October 17th vary widely. Economists at Standard and Poor’s put the figure in the neighborhood of $24 billion, or 0.6% of GDP. In addition, says the Congressional Budget Office, the public spending cuts known as sequestration – implemented in the spring of 2013 and reconfirmed by the recent agreement to reopen the government – could cost up to 1.6 million US jobs if kept in place through Fiscal Year 2014. Though other experts believe that the damage inflicted by politics on the economy has been smaller, the fiscal impasse in Washington has arguably taken a substantial bite out of the US recovery.

Households are not helping either. “Americans are still deleveraging for the most part,” says Chris Christopher, Director of Global and US Consumer Markets for IHS Global Insight. “Their liabilities to income are falling and have fallen quite dramatically since the crisis.”

In this respect, the latest Consumer Credit Report, covering the month of August, provides some useful insights (it is published by the Federal Reserve and tracks American consumers’ borrowing habits with data on credit cards debt and car and student loans). First and foremost, the report makes it clear that Americans continue to cut down on the use of credit cards, which, thanks to booming real estate and stock prices, had peaked in the years leading up to the collapse of Wall Street. “Either Americans are not using plastic anymore or they are paying down the debt on their cards,” says Christopher. “But my suspicion is they are just shying away from plastic.”

As of the second quarter of this year, outstanding revolving debt, which means mostly credit card debt, hovered around $850 billion, still well below the high water mark of more than $1 trillion in 2008. This, of course, is good news for the balance sheet of households but it is not necessarily great for the recovery, since it signals a certain restrain from spending.

At the same time, the report confirmed an uptick in non-revolving debt, meaning auto and student loans. Low interest rates are certainly helping car sales, which are coming back from the lows of the recession to levels not seen since 2007. However, data shows that people have been postponing replacing their old cars and trucks, driving up the average age of the US light-vehicle fleet, to a record 11.4 years. This has created pent-up demand, which accounts for much of today’s growth in sales. In short, this is about obsolescent vehicles being finally traded in for new ones rather than a booming market.

But it is the figures about student debt that tell the most concerning part of the story. This type of loans has ballooned since the crisis and continues to grow today. At this point it has passed the trillion-dollar mark to become the biggest driver of consumer borrowing after real estate. One could say this means that more and more Americans are getting the chance at a college education and that is a good thing. But the truth is that an increasing number of young people graduate with no prospect of a decent job and already burdened by tens of thousand of dollars in debt.

“This makes it harder for the younger generation to take the place of their parents as consumers,” says Steven Fazzari, Professor of Economics at the Washington University in St. Louis. “And businesses won’t produce what they cannot sell.”

At least, mortgage debt is still coming down from the out-of-control levels reached during the bubble years and so are delinquency rates (data from the Federal Reserve Bank of New York’s quarterly Report on Household Debt and Credit, the latest release of which covers the second quarter of this year). However positive, this trend presents problems of its own when it comes to economic growth.

“My worry is that we have lost the demand stimulus we had prior to 2007, which we needed to stay near full employment, from people borrowing against their rapidly rising home values to spend on houses and lots of other things,” says Professor Fazzari. “We’ve lost that demand which was supported in an unsustainable way by the housing bubble and haven’t replaced it with anything else.”

Against this already dire backdrop, workers’ wages have not been increasing for a long time. According to the Washington-based Economic Policy Institute, between 2002 and 2012 they were stagnant or declining for the bottom 70% of the wage distribution.

Add the fact that the federal government has long abandoned any plan to stimulate the economy, and you have a less than alluring economic climate. No wonder that US companies don’t feel any need to expand and are refraining from investing the piles of cash they are sitting on. According to a recent study by the St. Louis Federal Reserve, between 2008 and 2011 cash holdings by non-financial corporations grew at the stunning annual rate of 11%.

“I think business investment will not rebound strongly until the rest of the economy begins to grow more quickly. That is, business investment follows the cycle rather than leads it,” says Professor Fazzari. “Should demand rise from some other source, the high levels of business cash will help investment growth quickly, but we need something else to initiate the cycle.”

At this point, it is hard to tell what that something else might be. On the plus side, the stock market has been rallying and financial institutions, having substantially deleveraged, appear to be in much better shape than a few years ago. But, in reality, the only form of stimulus left for the US economy is the low-interest rate monetary policy and the bond-buying program, or quantitative easing, pursued by the Federal Reserve. Therefore it is unlikely that, given the overall economic picture and despite all the talk about imminent tapering this past summer, the American central bank will want to retrench any time soon.