Goodbye to the Good Times

11/11/2010 1:00 pm EST


Gary Shilling

Columnist, Forbes

Gary Shilling, editor of INSIGHT, explains why he thinks deleveraging—saving instead of spending—will keep global growth slow over the next decade.

The good life and rapid growth that started in the early 1980s was fueled by massive financial leveraging and excessive debt, first in the global financial sector, and later among US consumers.

That leverage propelled the dot-com stock bubble in the late 1990s and then the housing bubble.

But now those two sectors are being forced to delever and, in the process, are transferring their debts to governments and central banks. The federal budget deficit leaped from $187 billion in the 12 months ending December 2007 to $1.3 trillion in the 12 months ending August 2010, but it had little net effect on the economy as private-sector retrenchment more than offset the deficit jump.

Federal borrowing relative to [gross domestic product] leaped from 3.0% in the third quarter of 2007 to 10.7% in the second quarter of 2010, a 7.7-percentage point climb, but private borrowing fell from 15.2% to a negative 3.4%, a drop of 18.6 percentage points, or more than twice as much.

This deleveraging will probably take a decade or more to complete, [and] will result in slow economic growth and probably deflation for many years. And as Japan has shown, these are difficult conditions to offset with monetary and fiscal policies.

Another sovereign debt crisis in Europe may be in the cards, with Ireland replacing Greece as the focus. A further 20% drop in US house prices due to huge excess inventories and foreclosure delays may push underwater homeowners from 23% of mortgagors to 40% and precipitate a self-feeding spiral of walkaway homeowners and nosedive in consumer spending.

Nine Causes of Slow Global Growth in Future Years

1. US consumers will shift from a 25-year borrowing-and-spending binge to a saving spree.
2. Financial deleveraging will reverse the trend that financed much global growth in recent years.
3. Increased government regulation will stifle innovation and reduce efficiency.
4. Low commodity prices will limit spending by commodity-producing lands.
5. Developed countries are moving towards fiscal restraint.
6. Rising protectionism will slow, even eliminate global growth.
7. The housing market will be weak due to excess inventories and loss of investment appeal.
8. Deflation will curtail spending as buyers anticipate lower prices.
9. State and local governments will contract.
Source: Gary Shilling’s INSIGHT

Individual investors no longer trust their stock portfolios to finance future financial needs, despite the strong rebound that started in March 2009. They continue to yank money from US stock mutual funds and put it into bond funds, including postwar babies who invest more cautiously as retirement nears.

So, with investor uncertainty over their stock portfolios, home equity nearly exhausted, and high credit card delinquencies and charge-offs, American consumers have no choice but to curtail spending to save more and repay debt. The borrowing-and-spending binge of the past quarter century is being replaced by a saving spree.

Consumer retrenchment has continued despite repeated attempts by Washington to massively stimulate spending. From the recession’s onset in December 2007 through August of this year, consumers received $928 billion in federal stimuli, $559 billion in increased transfers such as unemployment benefits and extra Social Security payments, and $370 billion in lower taxes, mainly due to tax cuts. Still, of the $713 billion increase in after-tax income, consumers saved 59% and spent only 46%.

A saving spree in the next decade will also be encouraged by postwar baby saving. Those 79 million born between 1946 and 1964, like most Americans, haven’t saved much, and they accounted for about half the total US consumer spending in the 1990s. But they need to save as they look retirement in the teeth.

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