The precarious position of the US consumer (page 3 of 3)

This one ratio provides a striking example of a maladjusted qualitative distribution of the money stream, which usually becomes a factor of instability for the entire economy at some point.

I hope the reader will understand that the current mortgage financing boom and consumer credit explosion is simply not sustainable in the long run and that, at some point, credit expansion in the consumer and mortgage sector will slow down, as it has in the last two years in the corporate sector.

The consequences of such a slowdown will obviously be that consumer spending will have to slow down very considerably, which will inevitably hurt the economy, but hopefully will redress some of the external imbalances. So, whereas economists who point out that the consumer is in great shape may be correct now, sometime in the future the consumer may wake up with a terrific 'debt hangover', which will force him to retrench.

In this respect, some additional observations might be in order. In the third quarter of this year, household net worth fell 4.5% from the second quarter to $38 trillion, according to the Federal Reserve. The ratio of net worth to disposable personal income sank to a seven-year low of 4.9% in the third quarter from 5.2% in the second quarter and 6.3% at the end of 1999.

The drop in net worth resulted from shrinking assets and rising debt. Assets fell 3.4% to $47 trillion (mostly stock market related), while liabilities rose to $8.5 trillion, mostly as a result of the increase in mortgage debt described above. So, whereas in the late 1990s the equity bull market enabled households to boost spending and reduce savings, the recent bear market is leading to reduced spending and a rise in savings.

It is also in this context, and in order to boost the currently under-funded pension funds, which will become a drag on future corporate earnings, that we must understand the US administration's desperate efforts to boost the stock market a tout prix - even at the expense of creating other sets of problems such as the consumer and mortgage credit bubble we described above, a weaker dollar, and higher inflation rates for commodity prices, which will in turn depress bond prices.

In recent reports I have repeatedly drawn the readers' attention to the rise in housing and commodity prices over the last 12 months. The purpose was to show that, although we are in a deflationary environment for manufactured goods, principally because of the rising supply of 'cheap' consumer goods from China, a shift has taken place in the last two years from inflation of equities (or a bull market for equities) to inflation of hard assets such as residential real estate and commodities.

But whereas it would appear that housing inflation in the UK and the US is nearing an end, commodity prices appear to have completed a multi-year base and are poised for further gains. It is worth noting that despite weak global economic conditions and weak stock markets around the world, the CRB Commodity Futures Index has risen by more than 24% over the last 12 months.

Also, as I have pointed out previously, commodity prices have been in a bear market for more than 20 years and, in the age of capitalism, have never been as low as just recently. Therefore, once fundamentals improve, prices could run away on the upside. However, what do we mean by 'once fundamentals improve'?

For one, if synchronized growth around the world should materialize (a scenario about which we have serious reservations, but which is nevertheless a possibility for the short to medium term given central bankers' propensity to print money), then obviously the demand for all commodities should improve and drive prices higher.

But more importantly, with people like Mr. Bernanke at the Fed, and actually even being a serious candidate for future chairman of the Federal Reserve Board, depreciation of the dollar and a rise in commodity prices is almost guaranteed - particularly if the economy weakens. In fact, Bernanke's statements didn't go unnoticed by the believers in sound money (gold), who subsequently pushed gold prices through an important resistance level.

Therefore, if easy monetary policies bring about higher commodity prices, interest rates, which usually move consistently with commodity prices, will rise and bring an end to the current unsustainable mortgage-refinancing boom. And once the consumer can no longer borrow against his house in order to sustain his spending habits, consumption and along with it the economy are likely to collapse.

As a result, I would look at selling US equities during the present rallying phase, and avoid the US dollar and US treasury bonds. In my opinion, the euro and gold will continue to outperform US equities, as they have already done so over the last 18 months.