The misunderstanding of “debt-fueled consumption”

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This post is a guest contribution by Rebecca Wilder*, author of the of the News N Economics blog.

Today I plan to rant just a bit about consumption because I was reading Yves Smith’s article today, and she referred to “debt-fueled consumption” – the now pejorative phrase that just rolls off the tongue. She says:

“no where does the article [referenced WSJ article in her post on the consumption share] acknowledge that the consumption level was unsustainable and debt fueled.”

And this is where I get just slightly irked, because it seems to me that the phrase “debt-fueled consumption” strikes the following chord: every American household was loading up on home equity debt just to buy big ticket items like Hummers and large sofa sets with cup-holders galore from Jordan’s Furniture (a discount furniture shop in the Boston area – generically, every city has one).

I am sure that Yves Smith knows this, but the debt-fueled consumption was more likely paying surging health care bills than buying cute kitchenettes.

Myth 1: The years of debt-fueled consumption went into goods spending, jumping the consumption share of GDP to an excess of 70%.

debt-fueled-pic1

Reality: The goods share of total consumption has been falling quite dramatically, while the service component surged. Therefore, it is more likely that the debt fueled consumption was going predominantly into the service component (paying service bills).

In Q2 2009, 25% of service spending went to health care – outpatient services (physician, drugs, dentist) or hospital and nursing home services – and 29% of service spending went to housing and utilities – rent, water, electricity, and trash. As such, over 50% of service consumption is more likely to remain stable, even rise faster, with the Boomers out there.

And as for the speculation that workers are postponing retirement due the drop-off in wealth, and consumption will be meager into the medium term, I simply don’t buy it. If anything, the aging population is going to fuel recovery – no matter when they choose to retire. Service sector consumption growth – much of it based on health care consumption – will simply become a larger share of GDP growth (cutting out autos, perhaps), and pick up some of the slack.

And here’s another thing. Myth 2: durables consumption – i.e., autos and furniture – are important contributors to the initial stages of the recovery. It helps, but service consumption is the biggie.

average-contributions-to-growth-pic2

The chart lists the average contribution each GDP component during the initial year of recovery spanning the 1950-2007 (nine recoveries in total).

Reality: The average growth accumulated during the initial stages of recovery (1-yr following the recession’s end) following the last nine recessions is a remarkable 6.43% (consensus forecast for growth in 2010 is currently 2.3%). Only 0.47% of that came from durable goods. A huge 1.67% of that stemmed from the service component of consumption (again, health care and housing).

And as long as service spending rebounds, so too will the economy – even without a big pickup in autos. Inventories are almost a foregone conclusion, the residential construction sector is bound to pick up – 500-600k units is simply unsustainable for a US population that is growing at roughly 1% a year, and growth rates on such a small base can be large.

And here’s another link to jobs that has not been incorporated to many forecasts – growth in jobs means new health care insurance, means added spending on health care.

I could go on, but I won’t.

Source: Rebecca Wilder, News N Economics, August 19, 2009.

* Rebecca Wilder is an economist in the financial industry. She was previously an assistant professor and holds a doctorate in economics.

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4 comments to The misunderstanding of “debt-fueled consumption”

  • Nick

    The biggest debts consumers have are the mortgages on their houses, followed by car loans and credit card debts. There aren’t a lot of consumers who owe a lot of money to the hospitals and to the healthcare system.

    Healthcare costs are shared by taxpayers, employers, and common people. It’s not a straightforward consumer spending issue. A lot of that money comes from employers and the government.

    I think healthcare costs act like a tax on everyone and decrease their income for other types of spending. And if these costs increase too much, then this will damage the rest of the economy.

    The problem with US healthcare is that it’s very inefficient compared to that of other developed countries. Canada for example spends a much smaller proportion of its GDP on healthcare than USA spend. And Canada’s population is healthier than that of USA in terms of life expectancy and infant mortality.

    Inefficient and wasteful spending has never made people rich and never will. There is no way the healthcare industry can lead the US economy out of the recession. If anything, increased healthcare costs will likely drive the US economy deeper into recession. Because every other part of the US economy will decline from having their resources taken away in order to pay for more healthcare.

  • Just goes to show what a waste of time a doctorate in economics is. I’m sorry if I don’t elaborate but basically I’m supporting the comment by Nick.

    For goodness sake get a grip. If people did not spend to much on cars houses and commercial real estate and sub-prime loans were not a problem then I’ve wasted an awful lot of time the past two years reading and trying to understand this stuff. Thank goodness I didn’t decide to study economics.

    I wonder if Rosie could be enticed into setting up an on-line course? I guess we just need to read his letters.

  • Floyd Russell

    <>

    You could say the same thing about any form of spending. Buy a beer and you have less money for sox.

    Rebecca is writing about what the record shows to have been the case. She is only pointing out that more people, once things start o recover, start their spending for services and health care before moving on to other items later in the cycle.

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