Sunday, April 04, 2010

Our Credit Has Already Been Spent

First, a graph (click here for large version) - you may have seen it before, courtesy of Calculated Risk:

Then, an explanation via MatrixAnalytix, posted at ZeroHedge a few days ago.  I think this post eloquently explains a concept I've been trying to elucidate to explain why this time is different.  I'll c&p the three paragraphs here:

"The uptick in unemployment is directly correlated to the extreme tightening in credit standards we've seen over the past year or so. The environment of lax credit "easy money" we experienced over the past several decades artificially inflated the perceived purchasing power of households by most likely several magnitudes. If someone had $2,000 in bank but had a $10,000 credit card, there was no reason this person couldn't ratchet up credit card debt to the hilt and pay it off slowly. This was no doubt due to confidence in "job security." If I feel confident that I will have a job one year from now, I then believe that I will be able to finance any debt I may incur for the foreseeable future and can continue spending well beyond my earned income.

However, the underlying "bid" in the job market over the past several decades was ironically and without doubt directly correlated to this lax credit environment. In this environment, if someone with $2,000 in the bank had purchasing power of $10,000 and was more than willing to spend up to that amount + a percentage of earned income, then the demand for goods and services throughout the economy was in fact significantly driven by that credit portion of someones purchasing power and hence employers were bidding for labor based on a demand for goods and services founded on credit lines. In other words, high credit lines were producing "job security" which was producing demand based on easy access to credit lines...which was producing "job security", etc

Now what we've experienced over the past year or so is a significant retraction of those credit lines down to levels equivalent to real earned income. In other words, someone with $2,000 in the bank now most likely only has access to $5,000 in credit and that credit is most likely already spent. In other words, $5,000 of purchasing power has been eliminated from the economy and hence the demand for goods and services must be adjusted downward by the same amount unless the decrease is offset by an increase in spending by cash (which we know is not the case). Therefore, employers must now adjust their expectations of production to this lower level of demand which requires the need for less labor. Therefore, the bid for labor declines significantly, unemployment rises, and the level of "job security" declines. In the short-term this produces an increase in cash saving levels, and a decrease in demand for goods and services. The labor market is adjusting to a new paradigm in credit standards which are certain to remain for several years until cash levels increase to a level which allows for the re-extension of credit and confidence by creditors that those debt levels will be repaid in a timely fashion. In other words, expect unemployment to remain relatively high for several years until cash savings levels increase dramatically and credit lines begin to be re-extended. However, expect even when those credit lines are re-extended they will be to a much lower level than their previous highs as the market has seen the consequences of extremely easy access to credit, and hence the lows and new historical averages in unemployment will begin to rise in response to new lower levels of credit.

The bottom line:  we have a paradigm shift caused by the fact that our credit has already been spent.  That's a vast oversimplification of the problem, but still a good one sentence summary as to why I don't think that the economy can bounce back rapidly like it did in past recessions. 



Yangabanga said...

I think this is just another way of saying that unemployment isn't a dip but rather a fundamental change, now that spending is no longer powered by too easy credit.

Or put another way that it is much easier to grow in a ponzi scheme than it is "naturally". And it is even harder to grow again in the aftermath of one.

Kid Dynamite said...

yes yangabanga - exactly

But What do I Know? said...

While I agree with your point, KD, I think another issue is that the unemployment curve is shaped differently in the last two recessions because the job market is very different now than in the recessions of the past. When job swings were primarily in manufacturing (private industry with fast-acting demand changes) people were laid off as soon as demand slowed and added back when it picked up. But now the major job categories like health, education, and government do not quickly respond to reduced spending, and so the job losses take longer to happen (and to end). Another way to say it is that these enterprises are not motivated by profits, but by yearly budgets, and they are slow to respond to changes in revenue streams--both in hiring and in firing.