Cardiff Garcia writes
The second half of last year was puzzling to anyone trying to understand future trends in US consumption. Or at least it was to us.
Spending climbed more quickly than incomes, the savings rate decreased and consumer credit increased. Yet this decline in the savings rate happened against a backdrop of further declines in US home prices, followed a big fall in equities during the summer, and coincided with below-average consumer confidence — all of which you would expect to push the savings rate up, not down.
And that’s before discussing where we are in the deleveraging cycle, if it even matters, and other mysteries.
A lot of people think this way. I don’t.
I like to think in terms of the natural rate of interest. Then ask, is the Federal Funds rate above or below the natural rate. Above and the economy will tend to grow faster than long run potential. Below and the economy will tend to grow slower than long run potential.
The factors Cardiff named are ones that would tend to push down the natural rate
- Declines in wealth
- Declines in confidence
However, they must be set against factors which would tend to raise the natural rate, most important for us today:
- Increases in the Marginal Productivity of Capital
Lots of folks like the term “Pent-up demand” but it doesn’t sit well with me. Its just not how I see the world. Consumer durables are capital. They are just non-market capital. You use your car to do things. You use your washing machine to do things, etc. In some sense its household production all the way down, but we don’t need to go there today.
So, you are thinking about borrowing or saving some money. This is really a question of portfolio management. You can “save” which is to say invest in the economy wide capital or you can “borrow” which is to say invest in durables.
So, we then return to investing in durables goes up “your car breaks down”; “You have a new baby”, etc you will tend to want shift your portfolio towards durables and so the natural rate of interest rises.
What we say in the Great Recession was a massive collateral crunch that kept folks from investing in durables at the rate they would want. As a result the marginal return to durables skyrocketed.
As that collateral crunch easies folks will rush into buying durables because the return is enormous. They will do this even if they are heavily indepted already, just so long as the collateral crunch allows them to do it.
The reason a balance sheet recession can potentially go on for so long is that the collateral crunch is so severe that even though the return to durables is racing into the double digits its hard to get funds.
This crunch, however, rapidly eased in the US economy over 2011 at the same time that the return to durables skyrocketed.
This is what allowed me to – so far – successfully predict that durable consumption would skyrocket.
And, to be clear, I am no optimist. What is, simply is.