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Wednesday, June 15, 2011

Zombie consumers leading U.S. into lost decade

The global economy is being hobbled by a new generation of zombies - the economic walking dead. The American consumer is in the early stages of an unprecedented retrenchment. In the 13 quarters since the beginning of 2008, inflation-adjusted annualized growth in consumption has averaged just 0.5 per cent. Never before in the post-Second World War era have U.S. consumers been this weak for this long.

The zombie syndrome has an important antecedent. It was, in fact, a key symptom of the Japan disease, which led to the first of two lost decades for that country. Encouraged by the government, Japanese banks kept extending credit lines for a broad cross-section of insolvent companies - postponing restructuring and inevitable failure.

Japanese productivity growth weakened dramatically as a result of the ensuing “zombie congestion”. The lifeline of policy-driven bank lending allowed bankrupt companies to hang on to excess workers and redundant capacity. But that sapped post-bubble Japan of sorely needed vitality.

It’s comparable in post-bubble America. After a record buying binge that lasted a dozen years, U.S. consumers were stretched as never before. Consumption excesses were built on the precarious foundation of two bubbles - property and credit - which have now burst.

It will take a long time for American consumers to recover from the ravages of this bubble-induced spending binge. Deleveraging, the paying down of excess debt, has barely begun. Yes, household sector debt came down to 115 per cent of disposable personal income in early 2011. While that is 15 percentage points below the peak ratio of 130 per cent hit in 2007, it remains well above the 75 per cent average of the 1970 to 2000 period.

A similar pattern is evident on the saving side. The personal saving rate stood at just 4.9 per cent of disposable income in March and April 2011. While that’s up from the rock-bottom 1.2 per cent in mid-2005, it is far short of the nearly 8 per cent norm that prevailed in the last 30 years of the 20th century.

Like Japan’s banks, Washington policymakers are doing everything they can to forestall rational economic adjustments. The Federal Reserve has conducted two rounds of quantitative easing in an effort to get consumers to start spending the wealth effects of a policy-induced rebound in equities. The Congress and the White House have embraced home-foreclosure containment programs and other forms of debt forgiveness.

The aim is to get zombie consumers to ignore their festering problems and start spending again - irrespective of the wrenching balance sheet damage they suffered in the Great Recession. The subtext is Washington condones a revival of reckless behaviour.

Unsurprisingly, U.S. consumers are smarter than U.S. policymakers. With fiscal and monetary policies on unsustainable paths, households know that these life support efforts are temporary, at best. That means they need to take matters in their own hands. Sub-par labour income generation and historically high unemployment and under-employment for 24 million Americans only underscore the need for belt-tightening.

Spending retrenchment, deleveraging, and saving are the only sustainable options for America’s zombie consumers. That’s especially the case for 77 million ageing baby boomers - the first of whom are now hitting retirement age.

Like Japan’s zombies, there is no quick end in sight to the chronic weakness of American consumers. I suspect it will take a minimum of another 3 to 5 years before debt loads and saving rates have been restored to more sustainable levels. With consumption still about 70 per cent of gross domestic product, that points to sharply reduced growth in the U.S. economy - unless America is quick to uncover a new and vibrant source of growth. Policy paralysis in Washington is hardly encouraging in that regard.

There are important implications for the global economy. A protracted shortfall of the world’s biggest consumer, as well as weakness in Japan and debt-ravaged Europe, spells lasting pressure on external demand for export-led economies. Barring a quick rebalancing towards internal demand, so-called growth miracles in the developing world could be in for a rude awakening.

Sadly, America’s zombie consumers could be more problematic for the U.S. than Japan’s zombie corporates were for the Japanese economy. At 70 per cent of GDP, US personal consumption is 3.5 times the peak share of Japan’s bubble-distorted business capital spending sector in the early 1990s. A failure to learn the lessons of Japan - especially that of post-bubble zombie congestion - leaves the US and the global economy in a very tough place for years to come. Growth hungry financial markets could be very disappointed.

Stephen Roach is a member of the faculty at Yale University, non-executive chairman of Morgan Stanley Asia, and author of The Next Asia

Stephen Roach
The Financial Times
Published Wednesday, Jun. 15, 2011 8:13AM EDT
Last updated Wednesday, Jun. 15, 2011 8:22AM EDT
© 2011 The Globe and Mail Inc. All Rights Reserved.

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