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November - December 2003

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Looking Under the Hood
Exactly Why Dark Economic Days are Still to Come

by John Matukaitis

My last column expressed a synopsis of the many comments, opinions and conversations I have had with numerous people within our industry during the past few months concerning the economy.

Since that column appeared, I have received a number of calls asking me to, in a more specific manner, defend the view that the economy “is going to get a lot worse before it gets better.”

When asked to explain or discuss a somewhat complex issue, H. Ross Perot would respond that it is easy to see what was immediately around you, but to really understand what was going on one needs “to get under the hood and really check it out.” 

The macro-economic numbers of the past few weeks and months paint a pretty picture more or less. For example, unemployment, if not increasing is at least stable, the dollar is stronger, retail sales are good, deflation seems to be out of the picture, business spending is beginning to improve and it looks like we’re going to survive the collapse of the “bond bubble.”

The big questions that need to be posed are “is this sustainable?” and “is there a fundamental platform on which the economy can continue to grow at a minimal or moderate pace?”

Consumer Spending
Let’s look under the hood. In order for the economy to grow, consumers need to spend. Call me a pessimist, pragmatist or whatever, but without a source of liquidity there is no consumer spending. Where did the consumer get his liquidity that allowed him to keep buying during the past few years? There are four sources: his job, extracting equity from his home, taking out more debt via credit and debit cards and installment purchases. What about withdrawals from savings and investment accounts? The average consumer in the United States has virtually nothing in a savings account, and with minimal returns on most investments, there is not much to go around. Most investors are still trying to recoup their losses of the past few years.

The main source of liquidity is job income. Unemployment has dropped very slightly. But what about the half million people that gave up looking for a job? Approximately 750,000 manufacturing jobs have been lost during the past few months, probably never to come back. Many economists claim unemployment is a lagging indicator; first, the economy needs to pick up and then employment follows. How long is the lag? The Federal Reserve Board 

“officially” declared that the recession in the United States ended in November 2001. We are already 22 months in a “recovery” phase and jobs are still being lost while the true unemployment numbers are less than encouraging—an awfully long lag.

Decrease in Debt
One only needs to look at the huge amount of “re-finance” money that became available during the past two years. Goldman Sachs claims half of this was spent on consumption and home improvement. With rising interest rates, how much more of this money will be available, short-term and long-term, can the consumer afford it and have they already tapped out all of their homes’ available equity? Putting two of these factors together, how does one service this additional debt if he becomes unemployed?

Credit card defaults and personal bankruptcies are at an all-time high, not only in the United States, but around the world (keep in mind that we are dealing with a global economy, regardless what the Fed tells us). Demand for credit card debt and other forms of revolving credit has declined more than 2 percent in June, and more than 3.5 percent in July. Why is the consumer pulling back on credit? Yes, it (credit) is becoming more expensive, but more and more consumers are being cautious because they fear they may lose their jobs or not find one if they are seeking work. In short, they are not spending, or they are spending far less than they did a year ago. Numerous sources estimate that more than 60 percent of the money from this year’s tax rebate checks was used to service debt (i.e., pay down existing loans), not for consumption.

Installment purchases are also being affected negatively, just as credit card usage is. Buy a car, boat, siding for your home, carpeting, furniture, etc., with zero down and make no payments for a few months or up to a few years. But that means more debt, and an increasing number of consumers are avoiding these types of purchases. While under the hood, I noticed that the manufacturer of these items shows, on his books, that a unit has been sold when it is delivered. When will he actually deposit the money from the sale? Is this real economic growth or a form of forward hedging?

While we are still rattling around under the hood, pension funds for more than 300 of the S&P 500 show significant deficits. The GM deficit, for example, is more than its market capitalization. How will all of the baby boomer pensioners be able to spend money that isn’t there, or is less than it should be?

Higher consumer spending will come from increased consumer debt, both of which are beginning to abate. Have you noticed the proliferation of “non-profit” organizations that “work with you and your creditors” to reduce or eliminate your level of debt, with no cost to you? Amazing how that debt just disappears.

Yes, the economic numbers have been improving slightly. The core prerequisites for a fundamental recovery are not yet in place however. The job markets keep shrinking, consumer liquidity is approaching a significant slowdown and capital expenditures by business (capital capacity utilization) are still at historically low levels. I am not optimistic for a long-term recovery when no real fundamentals are in place. 

John Matukaitis serves as marketing director for Delchem Inc., based in Wilmington, Del.


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