Retail Sales Versus Debt Liquidation: Which Wins?

The phase of the recovery we are now in can be described as a tussle between two opposing sentiments for households. Do they go out and buy? Or do they pay down debt? Of course this is an aggregate view because there will be plenty of households in both camps. So it is the balance between these two opposing forces that we will need to track, especially as we go through the traditional year end selling season.

More to the point, this is a global tussle as well – more on that in a moment.

First: retail sales bounced up nicely, by 1.2%, in October. That makes it four straight months of growth and gives us a little room for maneuver as government spending tails away in the first part of next year. If we look at year on year growth the trend line is good, but not stellar. The bulk of the acceleration occurred earlier in the year, and even though we have consolidated that gain, we have not broken free of the constraints set during the crisis.

Still this is good news and helps us redefine what to expect over the next year. At this pace GDP growth should touch the upper boundary of a 2.0% to 2.5% range. That’s not enough to cure our problems, but it isn’t a collapse back either. All that talk of a double dip recession seems a long time ago now. After the stimulus stopped the rot, consumers have returned with just enough energy to keep us all afloat.

The big risk to all of this is the continued overhang of debt.

As long as the indebtedness of the economy runs at the extraordinary levels reached during the 2005 through 2008 period we will be hampered by the diversion of incomes into debt pay down and thus away from consumption. It is this aggregate shift towards savings – a debt pay down and a deposit into savings are the equivalent and both reduce consumption – that is currently setting the boundary on how fast we can escape the crisis.

Those GDP growth rates of around 2.0% to 2.5% are simply not enough to allow us to reconstruct a strong economy, reduce debt, and lower unemployment all at once. So when businesses look into the future to make expansion plans and set sales goals they are still expecting slow growth. Thus they pull back on investment and keep a tight lid on expenses and their workforce levels. Once an economy slips into this kind of mediocrity it is very hard to escape. The velocity is never sufficient to move to a higher orbit, and the dull outlook begets more dull results.

This story is being repeated on a global scale.

At this level the argument is between expansionists who want economic policy to be positive and apply the force necessary to create that “escape velocity”; and those who see dangers of inflation, currency devaluations, and a tide of deficits from such positive actions. The first group want more active policies. The second group want to retrench and shrink the worldwide economy.

The central issue is to achieve a fruitful balance between productive capacity, and the demand for goods or services produced by that capacity. The expansionists frame the discussion around the lack of demand. They see the problem as a need to induce more spending. The retrenchers want to shrink the economy back into alignment by curbing demand and, presumably, allowing idle capacity to linger on. The biggest part of that idle capacity is, of course, unemployed workers. What the retrenchers are not saying too loudly is that the only quick way to achieve balance through contraction is to reprice the value of the assets or labor that constitute the spare capacity downwards such that is can be absorbed at a lower level of activity.

Naturally I am an expansionist and advocate stimulating demand rather than imposing more wage and asset price reductions.

Yet the austerity, fiscal hawk, retrenchment argument is gathering force. The terrible financial difficulties in Ireland are being used as a stalking horse for more draconian policies elsewhere – even in places like the US where there are many more options than in Ireland.

What this all amounts to is an extraordinary misreading of history and a victory for long ago debunked economic theories. That we are even having this discussion is a symptom of the bankruptcy of those policy elites who drove us onto the rocks, and are now wanting to impose harsh and anti-social measures to counteract the consequences of their earlier mistakes. It is no coincidence that the creditors who are supposedly baying for austerity, else they won’t lend to us anymore, are the self same folks who bloated their incomes by peddling toxic assets a few years back. Having bailed them out we are now supposed to bend to their will and slash our wrists so as not to impose a cost on them. This is exactly the situation Ireland finds itself in. That we and others are beginning to cave in as well is scandalous.

So an epic struggle is unfolding, most people are unaware of it, yet its outcome will determine the livelihoods of hundreds of millions of people. Will we expand or contract? Will we stimulate or slash and burn? Will we spend or save? Will we invest or will we cry poverty and cutback? This is not trivial.

And right now the wrong people have the upper hand.