Stephen Roach believes that the painful economic contraction we’re about to experience will remind Americans of some basic truths about consumption. In today’s New York Times, Roach says that the period between the last recession and now has been marked by the unique phenomenon of assets-based consumption. We need a return to income-based consumption, and the transition is going to sting:
Consumers are now abandoning the asset-dependent spending and saving strategies they embraced during the bubbles of the past dozen years and moving back to more prudent income-based lifestyles.
This is a painful but necessary adjustment. Since the mid-1990s, vigorous growth in American consumption has consistently outstripped subpar gains in household income. This led to a steady decline in personal saving. As a share of disposable income, the personal saving rate fell from 5.7 percent in early 1995 to nearly zero from 2005 to 2007.
In the days of frothy asset markets, American consumers had no compunction about squandering their savings and spending beyond their incomes. Appreciation of assets — equity portfolios and, especially, homes — was widely thought to be more than sufficient to make up the difference. But with most asset bubbles bursting, America’s 77 million baby boomers are suddenly facing a savings-short retirement.
Worse, millions of homeowners used their residences as collateral to take out home equity loans. According to Federal Reserve calculations, net equity extractions from United States homes rose from about 3 percent of disposable personal income in 2000 to nearly 9 percent in 2006. This newfound source of purchasing power was a key prop to the American consumption binge.
As a result, household debt hit a record 133 percent of disposable personal income by the end of 2007 — an enormous leap from average debt loads of 90 percent just a decade earlier.
All of this begins with the artificial escalation of home values that began in the 1990s. Without those increases far outstripping inflation, consumers would not have had the equity to leverage for more spending. They would not have created a demand for even more debt, which fed on itself in a vicious cycle as government policies created profit on almost any kind of mortgage for short-term lenders.
The entire precipice was built on sand, and it’s now turning into quicksand. For some, the lesson will come too late. For the rest of us, it’s a lesson we need to learn for good. Many of us have heard the advice our parents and grandparents learned in hard economic times: Don’t spend beyond your means. Many in the previous couple of generations had a well-deserved skepticism about credit, and they’ve been proven right yet again.
While we’re at it, Congress could use an instruction or two in income-based spending, rather than asset-based spending. We’ve been mortgaging the next several generations in order to pay for our own pet programs for the last several decades. Maybe it’s time to stop doing that as well.
Here’s a question to ponder: The economy of the 1980s — which its critics like to chide for its excesses — turned out to be a lot more rational than the economy of the 1990s and 2000s, didn’t it?