In a tightening economy, with rising fuel and grocery prices, what products and services are going to be the first to feel the squeeze? Will consumers give up their three-dollar lattes, or concerts, or online music subscriptions? Or will they scramble for more ways to extend their run? Will they open new lines of credit wherever possible, maxing out their plastic and dipping into rainy day and retirement funds?
Such predictions are nearly impossible to make reliably. But if we run on the assumption that in the aggregate, consumers will actually tighten their collective belt, it seems prudent to take a stab at guessing which industries will suffer the most. There is some indication already that retail and the home improvement industry is turning south as foreclosures and lines of credit shut down—but what else will take a hit? In other words, when eating becomes too expensive, and the credit cards are tapped, where will consumers make their budget cuts? Here are a few of my guesses:
• Travel. The dollar is dropping like a stone against every other currency in the world—so scratch the big vacations to Europe, Asia, Africa, or the Galapagos Islands. Canada used to be a poor man’s foreign destination in such trying times, but the $US is at thirty year lows there, too. American’s will stay home—and they won’t even drive very far. Gasoline prices continue to climb, and for those consumers that lacked the foresight to buy economical transportation when credit was easy, their Navigators and Explorers and H2s will remain relegated to essential trips—to the grocer and work. (in a tightened credit environment, throw auto dealers into the well also) Airlines dependent upon tourism will continue to be unprofitable. Theme parks like Six Flags or Disney? I wonder how many consumers will be able to justify spending hundreds of dollars for what amounts to a day of silliness and thrills that you can get on a bicycle.
• Coffee. I have been astounded at the success of Starbucks and its imitators over the last two decades. A sure sign of perceived prosperity is when consumers are willing to spend three dollars every day on a commodity that costs twenty cents (or less) to make at home. I expect that we’ll see corner coffee shops evolve or shut down in the next few years. In a slightly related vein, we’ll see organic choices at the market much more rarely. Earth-love is fine when times are good, but in tough enough times even Ed Begley Jr. will eat the last spotted owl with a side of pesticide-laden, genetically modified French fried potatoes.
• Education. Will this be the economic contraction that finally has Americans rail against the high cost of education? I think so. It now costs hundreds of thousands of dollars to get an advanced professional degree from private institutions—more if you amortize the costs for several years after graduation. State schools approach the numbers more closely all of the time. Expect backlash. Community colleges, with their smaller classes and lower costs, will fill some of the gap, but they are already stretched, so less of the poor will be going to school. And what of elementary education? Will Americans who have chosen to send their children to private schools shift them to the thriftier choice of public schools? I think so, and this will put a sharper focus on our crumbling public education system.
• Media sources. These are another handful of examples of too much money for too little return. I think consumers will trim their movie rentals, their cable television, their video gaming, and their web access (Print media is already dead—no need to add it to the list). Basic cable will rule, and broadcast radio will become a better venue for advertisers that at any point in the past three decades.
• State, Local, and Municipal Services. Congress issued a report last week that showed the fallout from declining property values—ALONE—will result in about a billion dollars in lost property tax revenue for small governments in the next year. I believe their report was optimistic, and that they can add at least one zero to the number. Throw in lost sales tax revenue (in the many billions) and excise taxes for vehicles and such, and you’ll have a genuine crisis for local governments. What will they cut in the face of such austerity? Their biggest costs are education and health care for the poor—and public infrastructure. Cuts will hurt all three of these, but expect health care and roads to really suffer.
This is not an exhaustive list, just what I could think of over a cup of (home-brewed) coffee, and then post with my too-expensive high-speed internet connection. The next important question is; what will these changes do to the American economy? The unfortunate reality comes down to what economists call the multiplier effect.
Macroeconomic theory holds that the entire economy is a circle of exchanges. Employers (firms) pay workers, workers buy products, products come from the firms. Banks lubricate the whole process by providing liquidity (loans) so that firms can expand and take risks. If enough risks work out, the whole economy (Gross Domestic Product) grows. Central Banks can add or subtract liquidity (but not necessarily change GDP) with very minor adjustments to the closed loop of the economy. William Greider, writing in his outstanding work on the Federal Reserve (Secrets of the Temple: How the Federal Reserve Runs the Country, 1987, Simon & Schuster), likened the loop to a closed set of plumbing. Even a small addition of water to a closed system is felt immediately throughout the system.
It works (in an oversimplified way) like this: The Fed sets a target funds rate in their meeting—say a quarter of a percent lower than the current rate. This is an order to release more bonds (via auctions) onto the market, which dilutes demand for them, driving their effective yield down. As a result banks now have, on paper, more “cash” reserves. With more reserves, they can make more loans—because only a percentage of their loans have to be backed by reserves. Currently, US regulations require 10% cash reserves, so for every dollar that the central bank pumps in, ten more are added to the aggregate liquidity of the economy. But wait, were not done—that extra percentage of dollars adds to bank reserves as well! (It’s a circular model, you know…) So that percentage is multiplied into the economy’s overall liquidity: Repeat this cycle until the addition can only be measured in fractions of a cent. This is the multiplier effect, all from the Federal Reserve deciding to lubricate the market a little—no actual money is printed.
The problem is the multiplier also works in reverse. Tightening of liquidity shocks the entire system in the same ratio as loosening. Did I mention that the Fed can only add little changes—and that some market forces are beyond their control? Such is the case I believe we’re seeing now. The Fed can add liquidity all they want (I’m betting on a 25 basis point decrease in target at today’s meeting), but market sentiments still rule. When investors and banks believe they’ll need every bit of their reserves and then some to cover their bad bets, they don’t make the loans. Consumers feel this—the rates they pay on plastic go up, the spending caps come down, and their employers tighten belts as well (Maybe this year’s Christmas bonus is you get to keep your job…)—and adjust their habits, perhaps in the ways I’ve outlined above.
This means less of everything—less buying, less eating, less education, less taxpaying. This in turn means less road maintenance, more crowded classrooms, more automobile sales-of-the-century, and better incentives to purchase HBO. But if sentiment doesn’t turn right away—if consumers feel like this is going to be a long ride, the multiplier kicks into high gear. And remember, the Federal Reserve has less than five percentage points with which to play (barring negative rates, which Japan tried to no effect in the 1990s)
More loan and credit card defaults mean tighter money still. Housing may lose 40% of its perceived value, but still no buyers. Coffee at Starbucks might drop to $1.50, but who’s going to drink it when every penny counts? What I am talking about is deflation—and you won’t hear serious economists mention it in anything but a very quiet whisper, out of earshot, because to say it aloud is to increase its possibility. Like inflation, deflation is all about emotion, sentiment, gut feeling. None dare speak of it, lest it hears the beckon and visits.
We had serious deflation only once in the last one hundred years. It arose from World War I, and eventually became the Great Depression. The worldwide fundamentals are different now, with foreign GDPs growing robustly. Nonetheless, our nation owns 13.8 trillion dollars of world production—we matter. I truly hope that wisdom and coolness prevail, but I tell you now that I will experience only mild surprise if they do not.
NOTE: My loose-brained analysis may have several flaws—I wrote in a flurry.
