Tuesday, November 4, 2008

Next shoe to drop: pent-up demand

It never fails: "buy the rumor, sell the fact." Auto sales data released yesterday plunged, and as the chart shows they are abysmally low. Yet the market is rallying because it is looking ahead to the next new new thing. On that score, I would note that auto sales have fallen by one-third so far this year, but the number of people working has fallen by less than 1%, and real personal income has been about flat. That means the decline in sales of big-ticket items is temporary, a rational response to all the negative headline news. By pulling back, the consumer is building up his cash reserves (something that everyone has been doing of late). When confidence returns (as it is now returning to the equity markets, albeit slowly) then spending can rebound.


DaveinHackensack said...

How much of this demand was driven by cheap credit and home equity withdrawals? How strong will the rebound be if car loans are harder to get and have higher rates in the future?

Scott Grannis said...

I don't believe that demand has been sustained by cheap credit. In fact I question the whole notion that home equity withdrawals have been a significant factor driving the economy. See my earlier post on the subject of credit burdens:


Cheap money from the Fed was the basic problem, since that pushed everyone into "carry trades" that inflated housing prices, commodity prices, and foreign currency prices. All that is in the process of being reversed now, but money is still cheap. Some are finding it more difficult to borrow, but in aggregate, bank lending is at all-time high levels. The problem, as I've said before, is not a shortage of money, it's a shortage of buyers.

DaveinHackensack said...

I'd like to think you are right, but let me share a chart with you and see what your thoughts are on it. This is from John Mauldin, an estimate of what annual GDP would have been without mortgage equity withdrawals from 1996-2006, and I reproduce it here.

Scott Grannis said...

Dave: If it makes sense to exclude MEW from GDP, then it would make sense to exclude any and all borrowings from GDP. That would result in a huge reduction in GDP!

Of course that doesn't make sense. Just because you borrowed money (from whatever source) to buy something doesn't mean it doesn't count as a transaction.

Excluding all MEW also doesn't give consideration to the fact that a lot of the equity that people took out of their homes went to refinance other debt.

Consider also that any money I borrow using my home as collateral must come from someone else's pocket. Ultimately someone somewhere in the world saved that money and put it into the bond market and I ended up with it, and he ended up with a piece of paper.

If I didn't borrow it and spend it, someone else would have. I think we can say that most of the equity withdrawal by US households was financed by foreigners who wanted to invest in our market instead of buying our goods and services, and that was why we had a large and growing trade deficit. That growing trade deficit subtracted from GDP for many years, but the trade deficit is now shrinking and boosting GDP.