The Liquidity Trap: American Consumer Capitulates

http://www.nytimes.com/2008/10/31/opinion/31krugman.html

When Consumers Capitulate

By PAUL KRUGMAN
Published: October 31, 2008

The long-feared capitulation of American consumers has arrived. According to Thursday’s G.D.P. report, real consumer spending fell at an annual rate of 3.1 percent in the third quarter; real spending on durable goods (stuff like cars and TVs) fell at an annual rate of 14 percent.

To appreciate the significance of these numbers, you need to know that American consumers almost never cut spending. Consumer demand kept rising right through the 2001 recession; the last time it fell even for a single quarter was in 1991, and there hasn’t been a decline this steep since 1980, when the economy was suffering from a severe recession combined with double-digit inflation.

Also, these numbers are from the third quarter — the months of July, August, and September. So these data are basically telling us what happened before confidence collapsed after the fall of Lehman Brothers in mid-September, not to mention before the Dow plunged below 10,000. Nor do the data show the full effects of the sharp cutback in the availability of consumer credit, which is still under way.

So this looks like the beginning of a very big change in consumer behavior. And it couldn’t have come at a worse time.

It’s true that American consumers have long been living beyond their means. In the mid-1980s Americans saved about 10 percent of their income. Lately, however, the savings rate has generally been below 2 percent — sometimes it has even been negative — and consumer debt has risen to 98 percent of G.D.P., twice its level a quarter-century ago.

Some economists told us not to worry because Americans were offsetting their growing debt with the ever-rising values of their homes and stock portfolios. Somehow, though, we’re not hearing that argument much lately.

Sooner or later, then, consumers were going to have to pull in their belts. But the timing of the new sobriety is deeply unfortunate. One is tempted to echo St. Augustine’s plea: “Grant me chastity and continence, but not yet.” For consumers are cutting back just as the U.S. economy has fallen into a liquidity trap — a situation in which the Federal Reserve has lost its grip on the economy.

Some background: one of the high points of the semester, if you’re a teacher of introductory macroeconomics, comes when you explain how individual virtue can be public vice, how attempts by consumers to do the right thing by saving more can leave everyone worse off. The point is that if consumers cut their spending, and nothing else takes the place of that spending, the economy will slide into a recession, reducing everyone’s income.

In fact, consumers’ income may actually fall more than their spending, so that their attempt to save more backfires — a possibility known as the paradox of thrift.

At this point, however, the instructor hastens to explain that virtue isn’t really vice: in practice, if consumers were to cut back, the Fed would respond by slashing interest rates, which would help the economy avoid recession and lead to a rise in investment. So virtue is virtue after all, unless for some reason the Fed can’t offset the fall in consumer spending.

I’ll bet you can guess what’s coming next.

For the fact is that we are in a liquidity trap right now: Fed policy has lost most of its traction. It’s true that Ben Bernanke hasn’t yet reduced interest rates all the way to zero, as the Japanese did in the 1990s. But it’s hard to believe that cutting the federal funds rate from 1 percent to nothing would have much positive effect on the economy. In particular, the financial crisis has made Fed policy largely irrelevant for much of the private sector: The Fed has been steadily cutting away, yet mortgage rates and the interest rates many businesses pay are higher than they were early this year.

The capitulation of the American consumer, then, is coming at a particularly bad time. But it’s no use whining. What we need is a policy response.

The ongoing efforts to bail out the financial system, even if they work, won’t do more than slightly mitigate the problem. Maybe some consumers will be able to keep their credit cards, but as we’ve seen, Americans were overextended even before banks started cutting them off.

No, what the economy needs now is something to take the place of retrenching consumers. That means a major fiscal stimulus. And this time the stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn’t spend.

Let’s hope, then, that Congress gets to work on a package to rescue the economy as soon as the election is behind us. And let’s also hope that the lame-duck Bush administration doesn’t get in the way.

 

Stop this doom and gloom! Look at the bright side: "Spending on nondurable goods -- items like food and paper products -- shrank at the sharpest rate since late 1950"

Interpretation: people spending less on food and, hence, the toilet paper = leaner, healthier people. This is all good in the long run.

http://www.reuters.com/article/busi...081030?pageNumber=1&virtualBrandChannel=10112

 

That's true.

Less fat asses means median life expectancy will rise.

The problem is that the food industry will come out with cheaper 'food-like edible substances' that taste great, but cause 643 different kinds of diseases.

http://www.nytimes.com/2008/10/31/business/economy/31econ.html

Economy Shrinks With Consumers Leading the Way

By PETER S. GOODMAN
Published: October 30, 2008

Less than a week before Americans go to the polls to select a president, the government reported on Thursday that the economy contracted from July through September. In a stark indication of widening national distress, consumer spending dipped for the first time in 17 years.


Economists said the drop in economic activity — with the gross domestic product shrinking at a 0.3 percent annual rate — presages more bad news in the months ahead. The impacts of a now-global financial crisis are continuing to squeeze companies and impede investment, causing more layoffs and austerity, while prompting Congress to consider a fresh round of spending aimed at stimulating commerce.


A Newark job fair sponsored by Monster.com, the help-wanted Web site, was thronged on Thursday. Many expect unemployment to pass 8 percent by mid-2009.

“The economy has taken a turn for the worse, big time,” said Allen Sinai, chief global economist for Decision Economics, a consulting and forecasting group. “Consumption literally caved in. It is a prelude to much worse news on the economy over the next couple of quarters. The fundamentals around the consumer are all negative, and there are no signs of any help anytime soon, from anywhere.”

With the economy the dominant issue in the presidential election, the latest batch of dismal data offered no comfort to the Republican nominee, Senator John McCain of Arizona, who has been running behind the Democratic nominee, Senator Barack Obama of Illinois, in polls.

On Thursday, Mr. Obama seized on the latest evidence of the backsliding economy to warn that Mr. McCain would deliver more of the same.

“Our falling G.D.P. is a direct result of eight years of the trickle-down, Wall Street-first, Main Street-last policies that have driven our economy into a ditch,” Mr. Obama said while campaigning in Florida. “If you want to know where Senator McCain will drive this economy, just look in the rearview mirror. Because, when it comes to our economic policies, John McCain has stood with President Bush every step of the way.”

Mr. McCain’s campaign asserted that Mr. Obama’s efforts to increase taxes on wealthy Americans would deepen economic troubles.


An Economic Omen

“Obama’s ideologically driven plans to redistribute income will impose higher taxes on families, small businesses and investors,” Mr. McCain’s chief economic adviser, Douglas J. Holtz-Eakin, said in a statement distributed to reporters.

Economic downturns have proved unkind to the incumbent party in elections. Many analysts argue that the recession of 1990 and 1991 cost President George H. W. Bush a chance at re-election in 1992. President Jimmy Carter, a Democrat, lost his 1980 re-election bid to Ronald Reagan after a particularly nasty recession earlier that year. In 1960, in the midst of a recession, John F. Kennedy, a Democrat, defeated Richard M. Nixon, who had been vice president in the Eisenhower administration.

Not since 1900, when William McKinley, a Republican, won re-election, has the incumbent party retained the White House in the midst of a recession or within a few months after one.

In a statement Thursday morning, the White House acknowledged the weakening of the economy, while pinning the blame on a series of unusual events and arguing that the $700 billion bailout of the financial system would soon deliver relief.

“Today’s G.D.P. report is weak, but it is not unexpected,” said a White House spokeswoman, Dana M. Perino. “A number of things contributed to the slowing economy in the third quarter — record high energy prices, housing and credit concerns, two major hurricanes and a prolonged Boeing strike. The president is taking forceful actions to return the economy to growth and job creation by early next year.”

Whoever captures the White House seems certain to inherit a starkly challenging economic picture. The economy began slipping in the last three months of 2007, dipping at a 0.2 percent annual rate. Then it grew modestly for six months, aided by tax rebate checks, but has since succumbed anew to slowdown.

Consumer spending — which makes up more than 70 percent of American economic activity — dipped at a 3.1 percent annual rate between July and September, after growing at a 1.2 percent annual rate in the previous three months.

That was the largest three-month drop since the second quarter of 1980, a contraction that was in some sense artificial: the Carter administration, seeking to suffocate inflation, imposed limits on bank borrowing. Putting that episode aside, this year’s drop represents the sharpest decline in consumer spending since the end of 1974.

Economists saw in the data a testament to the degree to which many households are so strapped that the very culture of American consumption has been altered.

After years of pulling winnings from soaring stock markets, borrowing against the appreciating value of homes and leaning on abundant credit cards, Americans are finding those arteries of finance sharply constricted.

“The American consumer is finally hitting a wall that simply hasn’t been there for 17 years,” said Jared Bernstein, senior economist at the labor-oriented Economic Policy Institute in Washington. “What you see here is just a confluence of negative events closing every avenue that consumers have tapped over the years. There’s only a couple of ways that consumers can finance their spending. It’s labor income or nonlabor income, and both are on the mat.”

The economy has shed 760,000 jobs since the beginning of the year, with layoffs accelerating in recent months. Many companies have cut the hours of workers on the payroll, further diminishing paychecks.

Housing prices have continued to plunge, removing home loans as a channel for finance. Banks still reckoning with disastrous investments on real estate have cut credit even to people with relatively decent histories.

This month, consumer confidence, a broadly watched gauge of American sentiment in use since 1967, plunged to its lowest level on record, attesting to the new psychology of worry and scrimping that now holds sway.

Tucked into the data released Thursday was a worrying sign of a new, potentially pernicious phase of the downturn. Investment by businesses for things like machinery, trucks, computers and software slipped by 1 percent in the third quarter. If past downturns are a guide, that dip could swiftly accelerate, as companies recognize diminishing business opportunities and forgo purchases.

In the last recession, in 2001, this type of outlay, capital spending, slipped at a 14 percent annual rate in the worst quarter.

“When business decides it’s time to cut back, it happens quickly,” Mr. Sinai said. “They say: ‘We’re not hiring, so why do we have to buy equipment if we don’t have additional workers? Why do we have to replace equipment?’ ”

As orders dry up, layoffs accelerate, further diminishing spending power and further reducing business in a downward spiral.

This is the thinking behind forecasts that now broadly assume the unemployment rate could jump from the current 6.1 percent to beyond 8 percent by the middle of next year, a level last seen a quarter-century ago.

This is the image that has many analysts assuming that the next six months will bring more pronounced contraction, as the downturn deepens into the most painful recession since the early 1980s, and perhaps even the 1970s, when the oil shocks assailed the nation.

“We are now entering the harshest part of the recession,” Nigel Gault, chief United States economist for the research group, IHS Global Insight, declared in a note to clients.

One bright spot throughout the downturn has been American exports, which continued to advance in the third quarter, expanding at a 5.9 percent annual rate. But that was down sharply from the 12.3 percent clip seen from April to June.

Most economists think a continued slowdown in exports is inevitable as much of the globe follows the United States into disarray. The financial crisis born in the United States has spread to Asia, Europe, Latin America and the Middle East. Many countries that have been major buyers of American-made goods are now suffering.

“How are you going to export into that world?” asked Barry P. Bosworth, an economist at the Brookings Institution in Washington.

Another continued source of economic growth is government spending, which expanded at a 5.8 percent annual pace in the third quarter. Military spending surged at an 18.1 percent annual rate, and federal spending over all jumped at a 13.8 percent annual clip.

“There’s a message in that,” said Mr. Bernstein, the Economic Policy Institute economist, who has urged Congress to create another package of government spending measures to stimulate the economy. “The one part of the G.D.P. we can reliably count on in these times is government.”

 

In Bleak Times, the I.R.S. Looks Good


In Lower Manhattan, the line for an Internal Revenue Service open house began forming an hour before the event and would eventually wrap around the block.

By JAMES BARRON
Published: October 28, 2008

Benjamin Franklin said that nothing in this world is certain except death and taxes. When death is not an option and the world is maximizing the uncertainty, taxes look like an intriguing career alternative.

Or, more precisely, what the Internal Revenue Service calls tax administration.

The I.R.S. dangled the possibilities when it held an open house at the federal office building at 290 Broadway in Lower Manhattan on Tuesday. An hour before the fair was scheduled to begin, the crowd began lining up — recently laid-off Wall Street types in charcoal-gray pinstripe suits and trench coats; less formally dressed people; a woman with a new accounting degree on her résumé and a 14-month-old baby in a stroller.

Before their face-to-face encounters with I.R.S. employees, before they got a chance to hear about the agency’s “work-life balance” and its portable retirement plan, they had to do some waiting. The line for the career fair stretched along Broadway, turned the corner, ran down Reade Street and turned the corner again at Elk Street.

Once the job-seekers reached the lobby, they had to shed their umbrellas and rain gear. Following security guards’ instructions, they also had to remove shoes, belts and watches, and step through a metal detector.


Dave Reinhart gave up a job that required him to spend half of his time on the road. “With the I.R.S., I don’t think you’d have to do that,” he said.

Hope was an elevator ride away, on the 30th floor, where tables had been set up with handouts describing the particulars of different I.R.S. units. Employees of the agency were waiting to talk about their own careers but were not there to offer jobs on the spot. Most prospective applicants said they were told to go home and search a Web site — www.jobs.irs.gov — for positions they might be qualified for, and to apply online.

There were things the job-seekers were mostly mum about, like taxes. The presidential candidates have batted that subject around like a shuttlecock in a badminton game, but no one at the career fair was talking about the I.R.S. as a growth industry.

Kevin Somers, who has done illustrations for test preparation materials and comic books, said he was considering applying to the I.R.S. because the agency had been so nice when his freelance work dried up a few years back and he fell behind on his taxes. “The idea of the I.R.S. being ominous and threatening got turned around in my mind,” he said. “I see the I.R.S. as a way to help people.”

Dave Reinhart, 57, of Pompton Lakes, N.J., said he was interested in becoming a revenue agent — “someone who, as I understand it, reviews tax returns.”

“From what I’ve read about them,” he said, “they’re interested in hiring people in my age group.”

He said he had worked for AT&T and Lucent Technologies, as well as Home Depot, where he was in charge of installers for 43 stores. “I left when they told me I had to spend more than 50 percent of my time on the road, visiting stores,” he said. “With the I.R.S., I don’t think you’d have to do that.”

Some job-seekers said they were casualties of the financial meltdown. Jean Delice had already been laid off as a computer engineering specialist at Lehman Brothers when the firm, as he put it, “hit the rocks.” He said that the firm’s demise had cost him “everything,” including his severance package, and that the long-term prospects of a government agency looked pretty good.

“You could get a lucrative job in the financial market right now, but how long can you keep it?” he asked. “Everywhere I look, I see layoffs. If I take a $10,000 or $20,000 pay cut, in the long run, I’m ahead. The government is not in the trading business. It will be around.”

Warren P. Baker of Westport, Conn., a certified public accountant who worked at Price Waterhouse early in his career, said he had been a lender for JPMorgan Chase until March, when it purchased Bear Stearns, the venerable investment bank that was headed for collapse. Some jobs were soon eliminated, he said, including his.

“The banking sector will improve, but I’m not sure I’m willing to wait,” he said. “There are so many of us in the market. I applied for one job, and they said I was one of 90 applicants.”

He may not be willing to wait for the I.R.S., either. After making the rounds at the job fair, he was off to an interview at Bank of America.

 

Right after Obama takes over the leadership of the free world, we won't be reading about such terrible stuff!!

 

That's right--He won't allow it to be written, let alone read by anyone.

 

him personally, or will he need lots of help? do you know how much such a position would pay, and would there be benefits like social security, medical, vacation etc?

 

Not true because healthier food costs more than non-healthy food.

Interpretation: People spending less on food because they can't afford higher priced, healthy food = fatter, unhealthy people. The $1 menu at MCD's has gone into hyperdrive.

 

Krugman is by far the sharpest economist we have.

 

That is the funniest thing I've read in a while