A New Consumer Splurge? Don’t Hold Your Breath

With Europe in a funk and Asia’s economic powerhouse sputtering, is the American consumer ready to pull out her credit card and rescue the global economy?

Some analysts seem to think so, but I doubt it.

U.S. households have been reducing their debt levels for the past five years, by paying it down in some cases and defaulting on it in others. A sharp recession and long bout of high unemployment has put a damper on consumer spending, which represents close to 70 percent of our economy. Manufacturing and exports, especially to Asia, provided what little impetus there was for economic growth as we emerged from the downturn, but those bright spots have faltered along with overseas economies this year.

We may be reaching a turning point. In a recent Bloomberg article, Mark Zandi, the chief economist at Moody’s Analytics Inc., declared, “The household deleveraging process is largely over.” Household debt as a share of disposable income hit 113 percent in the second quarter, compared to the high of 134 percent in 2007. The credit card delinquency rate hasn’t been lower since the end of 2008.

GDP is growing as well, albeit slowly, and retail sales were up 1.1 percent in September. Household net worth as a percentage of income is also on the rise, and the number of foreclosures is falling.

There is clear evidence that the typical American household’s financial picture has stopped getting worse and is probably getting a little better. This has inspired hope that the consumer is ready to start consuming with more enthusiasm. As Zandi put it, “Credit use should soon go from being a significant headwind to the economy to a tailwind.”

The reduction in household debt and the concurrent rise in household net worth surely is good news for Americans and good news for the economy. But, although pent-up demand from the past several years will certainly need to be satisfied, I don’t think most U.S. householders are going to party like it’s 1999 – or even like it’s 2006 – any time soon.

There are several reasons. First, an entire generation (the baby boomers) built a standard of living on easy credit that began with taking vacations and buying furniture on credit cards. Unlike their parents, boomers were not big savers. They are now approaching or entering retirement with, far too often, a pittance in the way of personal assets. They’ll still get Social Security, and the lucky ones have well-funded pensions or ample 401k(s), assuming they were wise enough not to liquidate stocks during the recent crash. Yet those with comfortable savings cushions are the minority. According to a study released this spring, only 45 percent of respondents in their 50s reported contributing to a defined contribution retirement plan, and even fewer to either a Roth or traditional IRA.

Whether they admit it or not, the boomers know they made some big mistakes. Their kids seem inclined to be much more conservative with their finances. Part of that is due to the high unemployment rate young workers face and the crush of student loan debt, but it also seems likely that their spending habits have changed for good. The boomers themselves often lack both the inclination and the resources to go back to their old spend-and-borrow habits. Neither the boomers nor their offspring seem to be primed to go on a borrowing spree.

Second, Americans read the news. They are well aware of their government’s massive debt. It does not bode well for either taxes or spending in the long run, and many people either know or sense that the costs will not be borne by a mere 1 or 2 percent of the population. The outlook gets even worse when you consider the shaky condition of many states’ and municipalities’ finances. A strong personal balance sheet, with ample assets and modest debt, provides a personal cushion against what may lie ahead on the fiscal front.

Third, people want to know they have something to tide themselves over if they lose a job and can’t get another one quickly. The lingering, extended period of high unemployment is not going to inspire consumers, especially those with mortgages to service, to loosen their purse strings very much. It certainly isn’t going to encourage them to dive deeply into debt again.

Fourth, despite the record-low interest rates that exist on paper, the reality is that many, if not most, individuals and small businesses continue to find it very hard to actually obtain credit. It’s certainly much harder than it was during the easy-money days of five or six years ago. Banks are afraid to make any loans that might possibly go bad, or to issue any consumer debt that might be viewed  as exploitative after the fact by newly aggressive regulators. If nobody will lend to you, you can’t go into hock even if you are so inclined. We are living in a schizophrenic world of low interest rates amid tight money, and we aren’t getting back to business as usual any time soon.

If I am correct, the deleveraging process will probably continue for quite some time to come. Just because it won’t necessarily kick-start the overall economy does not mean it lacks value. A world in which Americans borrow less and save more is not going to be very exciting for short-term business prospects, but it a constructive step toward building a better future in the long run.

About Larry M. Elkin 525 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

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