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The Role of the American Consumer in the Financial Crisis

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As we stand now, in the midst of the worst financial crisis in recent American history, there is plenty of blame to go around. For the most part, blame has been rightly directed towards Wall Street for its greed and recklessness, and at Washington for its incompetent regulation and inability to fix the problem. However, one of the primary culprits in the financial crisis has heretofore largely escaped criticism – the American Consumer.

For the last 25 or so years, Americans have been on a spending spree. Our houses, cars, wardrobes, and gadget collections have all gotten larger and more expensive. Long gone are the days of frugality and good value.  In their place stand opulence and the Consumer Culture. To be sure, Corporations (including the media) have encouraged this behavior. But we've gone along, willingly.

However, while all this spending was going on, the American Consumer was not necessarily getting much richer. Real incomes increased much more slowly than consumption, and as a result, our savings rate decreased and net debt increased. Also, our economy became increasingly dependent on consumption.

Fast forward to today. Consumption in the US is about to fall off a cliff, and the US economy with it. Piggy banks have been emptied and credit cards have been maxed out. American Consumers are so laden with debt they cannot spend another dime. And this is before things get really bad. The lay-offs are coming soon. Unemployment will shoot up at least another few percent (5M jobs lost?), credit will remain unavailable, so consumer spending will have nowhere to go but down, putting more pressure on the economy, causing more lay-offs, and the vicious cycle continues.

So what happens next? The Consumer Culture that has permeated Western Culture will have to change. Perhaps it will again be cool to be frugal (Warren Buffett, anyone?). Perhaps we will focus more on the non-material aspects of our life – spending time with family, friends, community – import parts of life that have too often been neglected in our race to produce and consume more. And perhaps that is the silver lining. There can be no doubt the American Consumer has been culpable in the build-up and the decline of the American Economy. But in the end, perhaps that is okay. Perhaps the Financial Crisis will be the wake up call people need to appreciate the things in life that have nothing to do with the economy.

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About Jeremy Berman

  • Clavos

    Your premise of blaming exuberant spending by consumers for the problems besetting a consumer-driven economy is, to put it mildly, bizarre.

  • http://www.sitejabber.com Jeremy

    Which bit is bizarre? Perhaps I was unclear…

  • Heloise

    Clinging to the “it’s the poor folks stupid” meme? Mind you I think they played a puppet’s role in many cases. Has anybody mentioned how the influx of illegal aliens building up the housing glut helped to fuel the spending spree of rich and poor alike? No, not exactly.

    When folks went to the bank and bankers were willing to loan them, but not poor Heloise, $300,000 on a NINJA salary were they spouting my “thanks but no thanks” to the bankers? I don’t think so.

    I just read a chapter from an FDR biography and anyone who thinks that history does not repeat itself, simply does not know history.

    Roosevelt when faced with the post-Wall street crash had to “prime the pump” according to the author, Frank Freidel. How exactly did FDR prime the pump? He infused a whopping 7 billion dollars into the economy. He was attacked by both right and left on most of his economic new deal stuff, an assassination attempt foiled by a woman, faced the evil cabal of southern white men who refused to vote for the Antilynching bill that he helped write into law.

    All this and more done in the 1930’s. Lynching was law as early as 1937!

    So, while Bush is no FDR he has had to do what FDR did: 700 billion into the pump. What kind of wild spending were the poor folks, and regular folks doing that led to the market of only 9! Yup it fell to 9, and at least we are close to 9,000.

    But everything is relative, according to Einstein.

    Heloise

  • Clavos

    The whole thing, Jeremy.

    To blame consumption for the failure of an economy whose well being is based on consumption doesn’t make sense. If all Americans were to follow your suggestion to reduce their consumption, the economy’s problems would be exacerbated, not helped.

  • Heloise

    I saw this coming last couple of years when I went online got a scottrade account and starting putting thousands into the stock market. Folks were peddling penny stocks that would hit one dollar and then fall to a penny! I played with the market using up to nearly 20K.

    When apple hit 200 dollars and I couldn’t sleep at night because of the roller coaster ride the market has actually been doing the past two year! I took all my money out nine months ago and then I could sleep.

    Summer 2007 recall when Bernanke cut the prime rate and stocks shot up? That should have told everyone something. That the markets were so unstable that infusions of cut rates, many, were all it took for the market to rally a cool 500 points in one day until it hit the all-time high of 14,000.

    That book I read and someone reviewed here on markets and messiahs is what I think actually “scared me stockless.” LOL. It said YOU cannot beat the market, it will beat you. I lost about 800.00 last year but would have lost 8,000 if I had not acted.

    Heloise

  • http://www.sitejabber.com Jeremy

    Clavos – that is precisely my point. Our economy became too dependent on discretionary spending and luxury goods. And now that will probably change. Economic growth in the next decade will likely come less from our production and consumption of yachts, and more from practical expenditures like rebuilding our nation’s crumbling infrastructure or creating new innovative sources of energy.

  • Clavos

    Clavos – that is precisely my point.

    I know, and my point is that advocating a reduction in consumer spending to solve the problems of a consumer economy is completely backwards.

    And now that will probably change.

    Don’t bet on it, Jeremy. You say:

    Economic growth in the next decade will likely come less from our production and consumption of yachts, and more from practical expenditures like rebuilding our nation’s crumbling infrastructure or creating new innovative sources of energy.

    One doesn’t preclude the other.

    On the contrary, infrastructure rebuilding will likely enrich thousands and even millions of folks working in that effort. Likewise, R&D money spent to identify, develop, and market alternate energy will do the same. You are correct that we need to do these things, but the net effect will be to generate even more, not less, economic activity and therefore, even more wealth.

    The fact is, ours is and will remain, a consumer economy. What’s more, all the emerging economies are clamoring to join the ranks of consumer economies. Nations like India and China are accelerating their production and consumption (and export) of goods at an accelerating pace, just as Japan and Taiwan (among others) did, with great success, before them.

    The flaw in your premise is that you’re assuming wealth is a zero sum, that it is finite. You’re assuming a limited amount of wealth being available for all demands. Neither our nor the world’s economies are zero sum entities; they haven’t stopped growing globally or in the long term, and increasingly, economics is interlinked on a global level.

  • http://www.sitejabber.com Jeremy

    Clavos – I’m not advocating anything – simply pointing out that consumer spending as a percent of GDP became unsustainable(it went from 66% of GDP in 1987 to 73% in 2007), and I’m suggesting that reducing our economy’s dependence on consumer spending may not be a bad for our country, even if that means economic contraction in the short run. Plainly wealth creation is not a zero sum game – I’m not sure where I suggested that, but apologize if I left that impression.

  • Clavos

    If wealth creation is not zero sum, then why reduce any segment of the economy that also creates wealth? That in fact, is historically the strongest sector of the economy?

    You say that “consumer spending as a percent of GDP became unsustainable(it went from 66% of GDP in 1987 to 73% in 2007).” “Unsustainable?” How?

  • http://www.sitejabber.com Jeremy

    Consumer spending is/was unsustainable because Americans were spending beyond their means. That is, their earnings were increasing at X% per year, but their consumption was increasing at X+Y% per year. As a result, Americans were digging themselves deeper and deeper into debt. Total debt in the US went from around 150% of GDP in 1978 to 300% today. The American consumer cannot continue to be the engine of growth in the American economy because they essentially do not have the money to spend.

  • Clavos

    I think you will find that, in the long term, american consumers will continue to be the mainstay of the economy, just as they have in the past. This will be especially true if, as you suggest, we focus on the needed rebuilding of our infrastructure and research and development of alternative energy sources, both of which, as I said above, will enrich a lot of americans as they unfold.

    Excessive credit card debt did not cause the economic meltdown; by all accounts, it wasn’t even a contributing factor.

    Historically, credit card debt has fluctuated up and down. In all probability it will decrease, short term, as the economy contracts, but I very much doubt that in the long term, personal consumption will cease to be the principal engine of our (or even the world’s) economy.

  • http://www.sitejabber.com Jeremy

    I’m not arguing that consumer spending will go away or even cease to be an important part of our economy. But I am arguing that consumer spending will come down dramatically and stay down for a long time. A good summary of the consumer side of the situation can be found here.

  • http://drdreadful.blogspot.com Dr Dreadful

    Clavos, given your line of work I understand your reluctance to get on board with Jeremy’s assessment, and in one aspect of it he is way off beam.

    But Americans do tend to spend like crazy when they get the chance. My hair curls sometimes at the sheer ease with which a certain person close to me 😉 is capable of enhancing the wealth of our local department stores.

    Now consumers are, I think, going to rein in their spending in ways that may last a while. My father-in-law just wrote off his Lexus, but rather than get a new one he opted instead for a Toyota Yaris – the car with the best gas mileage he could find! (He commutes long-distance.)

    Consumer culpability, though, lies not so much with raw spending as with overstretched credit.

    Nonetheless, kudos to Jeremy for breaching an interesting aspect of the current crisis which is (understandably, given the timing) little discussed by politicians.

  • Clavos

    Can’t argue with much of your comment, Doc, especially not this:

    Consumer culpability, though, lies not so much with raw spending as with overstretched credit.

    That’s about the only thing the consumer is guilty of, and that has precious little to do with the crisis; as you know CC credit is an entirely different animal from the subprime mess.

    As for the boat biz: as I’ve mentioned before, only the lower categories have slowed down, and only with American buyers. It turns out that there’s a lot of money burning holes in pockets in the former Soviet countries: having successfully tapped into that market, between us, my partner and I have had an excellent year (my personal best in all ten years I’ve worked at this job).

  • http://www.sitejabber.com Jeremy

    Clavos – when the word “credit” is used in the economic sense, it encompasses more than credit card debt. It can be thought of more as “leverage” or “borrowing.” So in the case of the American consumer “credit” might include mortgages, student loans, car loans, home equity lines, and credit card debt, among other items. All of these forms of credit have been used by consumers to spend beyond their means. I would argue the fallout from the housing crisis is just the beginning of a vast change in the way Americans spend money (ie, they will now spend much much less).

    Dr Dreadful – thanks for the compliment. I would only point out that although consumers had access to too cheap credit (part of the problem), no one made consumers use it. Consumers decided to take out more debt and keep spending which has in part led to the state of the economy today.

  • http://www.associatedcontent.com/user/39420/joanne_huspek.html Joanne Huspek

    Consuming products in this marketplace is one thing. Going into debt to one-up the Joneses is another.

    Has no one heard of spending only what you have? Or am I a dinosaur? (And believe me, I’m not that thrifty…)

  • Clavos

    I would argue the fallout from the housing crisis is just the beginning of a vast change in the way Americans spend money (ie, they will now spend much much less).

    Based on what?

    The client who just this weekend signed a contract to buy a $4M boat from me certainly isn’t “spending much less.”

    I would argue (as I have already) that any contraction in consumer spending will be relatively short lived, as it always has been in the past, particularly among the wealthy, who so far don’t even show signs of slowing down.

    I guess we’ll just have to agree to disagree, Jeremy.

    I have not seen any convincing evidence (as opposed to opinion) from you yet that consumers will cut back on a permanent or even a semi-permanent basis; not in your article, and not in your responses.

  • http://www.sitejabber.com Jeremy

    Clavos – the slow down in consumer spending has already started. You can check out the US Government’s data and it was reported also in the New York Times.

    But the most important implication is for the future, in which spending will slow much more drastically. The logic goes: consumers have less wealth from their homes and stocks, less real income, expectations of lay-off, no more access to credit, therefore, they cannot keep consuming at previous rates.

  • http://drdreadful.blogspot.com Dr Dreadful

    It turns out that there’s a lot of money burning holes in pockets in the former Soviet countries

    Well, when they’re not buying English soccer clubs

  • Clavos

    Clavos – the slow down in consumer spending has already started. You can check out the US Government’s data and it was reported also in the New York Times.

    Of course it has, Jeremy – there’s a recession on – I never said it wouldn’t slow down temporarily.

    It’s not going to last, though. Why? Because the public have short memories; as soon as things ease a little, all the pent up demand will come back into play. And good thing too; without strong consumption, we don’t have an economy.

    So far, what I’ve seen from you is what you think the consumers should do henceforth, no evidence that they will cut back permanently. Since they never have in the past, I think you’re mistaken (without some concrete evidence) to assume they will this time.

    Not only that, but in your article you actually propose that it would be good for the economy for consumers to cut back permanently. Given that our economy is based on consumption, I say that would be very BAD for the economy.

  • http://www.sitejabber.com Jeremy

    Clavos – personally, I hope you’re right – I hope our economy recovers quickly. But given the data, I just don’t think consumer spending will recover for many many years.

  • moon

    Give the consumers a break: They only followed orders.

  • bliffle

    Clavos is right: the USA economy is paced by consumers. Producers merely obey the commands of the market economy.

    And that’s why it’s wrong to direct favorable tax cuts and subsidies at producers, and why it’s right to direct such benefits at consumers.