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What If U.S. Consumer Spending Habits Have Change Forever?

Uncertainty has plagued financial markets over the last few weeks as the economic recovery has slowed significantly in the United States and other developed nations.  Late last week monetary policy makers from around the world convened in Jackson Hole, WY to discuss the current global economic recovery and possible further action steps.  Market participants were looking forward to Fed Chairman Ben Bernanke and European Central Bank President Jean-Claude Trichet’s speeches, hoping they would offer some clue concerning future policy decisions surrounding an ever-weakening recovery.

Instead of clarity, market participants were once again offered vague promises.  Mr. Bernanke promised that the Fed would step in and “do whatever it takes” to stimulate the U.S. economy.  His prerequisite for action is that the U.S. economy show further signs of deterioration, which is very interesting because there are pretty significant signs of deterioration already in place.  Unemployment is at stubbornly high levels, consumer confidence is low, retail sales are low and economic growth prospects are being steadily downgraded.

This week is has a heavy flow of U.S. economic data on the calendar with FOMC Minutes leading the show on Tuesday.  The FOMC Minutes tend to not have as much market-moving potential when they are released directly after Mr. Bernanke giving an important speech as he did on Friday.  Mr. Bernanke most likely communicated in his speech on Friday anything that may be in the FOMC Minutes.

The rest of the week is full of data from the manufacturing, housing, and jobs market with Non-Farm Payrolls due for release on Friday.  The Non-Farm Payrolls release on Friday should give market participants a very clear picture concerning the state of economic recovery in the U.S.  The number is expected to come out at -101k.  If the number surprises to the downside significantly and if other economic data throughout the week confirms a further slow-down in the U.S. recovery, then the Fed may be forced to take a further step of quantitative easing.  Among economists and monetary policy makers, there are various opinions on what the Federal Reserve should do and how Central Banks and governments should handle this current slow-down in the global recovery.

Will Further QE Measures Help?

A major concern among many economists is the cost/benefit analysis of further QE measures.  Studies are beginning to show that further measures may not help the economy much.  The question many people have is if we institute another round of QE measures and increase the Fed’s balance sheet, how much will it help the economic recovery.  The problem is that is may not help much at all.  Thus, we have the high cost of QE measures and the low benefit of small economic impact.

There are other very outspoken critics of further QE measures as well including European Central Bank President Jean-Claude Trichet.  Trichet believes the Federal Reserve and other Central Banks around the world need to reign in government spending and attack huge, ballooning fiscal deficits.  This topic is a huge source of debate among key leaders around the world, and unfortunately there is not clear cut definite answer concerning which side is right and which side is wrong.

The main challenge in the current recovery is two-fold.  One, banks are not lending.  And two, people are not spending.  Credit markets are still very tight and this is causing huge problems for small businesses in America, and small businesses are the backbone of the U.S. economy.  If credit does not begin to flow easily again, then small businesses will not be able to expand as they want, and that means they will not be able to hire more workers, which means unemployment will remain high.  When unemployment remains high, consumer sentiment weakens and people do not spend money.

Consumer Spending Habits

Personal savings rates are at HI’s we have not seen since WWII.  The unfortunate thing is that spending is how an economy gets out of recession and economic trouble.  If there is no spending during a recession, the recession will simply get worse, and that is what is happening in the United States.  Consumers are now feeling the very negative effects of reckless spending and they have, therefore, cut back on spending and increased savings.  John Maynard Keynes, the early 20th century economist responsible for creating our current modern economic system, stated that personal savings during a recession is one of the worst enemies of economic growth.

Thus, governments are to step in and spend during a recession to stimulate economic growth and replace the private sector spending that has disappeared.  Then, as the economy corrects itself and emerges from recession, personal spending will again increase and governments can scale back their stimulus efforts.  What happens, though, if consumers never begin to spend again?  What happens if there is a complete transformation of consumer behavior?  This is a topic that most economists are not confronting.  It would be debilitating for the U.S. economy in the near-term, as it would pretty much guarantee a mult-year period of very slow economic growth and possible deflation.  But would it be good in the long-term?

This is a topic that economists and financial thinkers must begin discussing.  Much of the prosperity in America is not actual prosperity, but it is an illusion based on insane leverage and irresponsible spending habits.  Our current economy is based on consumer spending and heavy amounts of credit.  If both these elements are scaled back considerably it will change the very face of American economic system and even what Americans perceive as “normal life.”  But it could be very good for the long-term health of our country.  The average middle-income American lives a life that was reserved for the wealthy just a generation before, but at the same time most middle-income Americans have little to no savings for emergencies or retirement.  A true transformation of the American economy may be needed.  Perhaps we don’t need further stimulus measures.  Perhaps we should let the free market correct itself, purge the system of economic waste, and lead Americans into a future that is full of economic responsibility and true prosperity, instead of the false prosperity that has become so accepted in our modern culture.

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