Commentary

Consumers High on Hope

Consumers are high on hope, choosing the drug peddled by politicians, mall operators and bankrupt car makers, over the dismal news coming from the housing and job markets. Consumer sentiment, the lifeblood of the American economy, climbed last month to the highest level since last year. The faint glimmers of good news in some areas of the economy, along with a heavy dose of spin from the political set, is creating a mind-altering intoxicant for millions of Americans who want to believe that the financial crisis is past and that clear skies will emerge soon. This is lunacy, and I will explain why in the paragraphs below.

First, a look at the numbers from Maketwatch, which provided a neat summary of May’s sentiment readings:

The Conference Board’s measure of consumer confidence was up 35% from April, the fourth-largest jump in the 32-year history of the index. The move left consumer confidence in positive territory at 54.9, the highest it has been in eight months. The gain was far bigger than economists expected.

Marketwatch also explained why this healthy, yet misguided bounce occurred:

Consumers clearly believe the worst is behind this economy and the market, when it’s not clear at all to the experts that the U.S. can avoid another leg down — or worse — en route to a broad-based recovery.

Consider that there was a big increase in the percentage of consumers expecting the economy to generate new jobs, despite no evidence that the current economy can actually achieve that.

Now, back to reality. The American economy is hemorrhaging a half milion jobs a month, and the housing market continues to struggle (read: The NY Times “Home Prices Continued Their Decline in March”). Consumers are still in the early stages of repairing their tattered balance sheets, which will put a damper on spending in the months – and years – ahead. I believe that the rate of decline in economic activity has paused for the moment. The forces that caused the credit bubble and the housing boom are still unwinding. Industries that fed from the trough of easy money will continue to suffer. The financial, auto, construction and retail sectors, which benefited the most from this unhealthy diet, will continue to shed jobs as they adjust to a more sustainable share of the economy.

How can consumers be so blind to what is about to smack them about the face in the months ahead? The answer is quite simple. Through smoke and mirrors, the Obama administration has restored a respectable level of confidence in the banking system. The administration also breathed artificial life into the real estate market through incentives to buyers and guarantees to lenders, and it lifted the auto industry from the grave and placed it on an expensive life support system. Emerging economies, China in particular, appear to be shrugging off the credit problems of their western trading partners. Many businesses around the globe have completed a painful round of inventory and production capacity reductions. And, commodity prices have been showing signs of life.

Many a pundit and politician are grasping desperately at this stream of moderately positive news and delusional hype, shouting to the nation that the worst is over – and can you blame them? After all, people eventually ignore those in the media who persistently beat the drum of doom and gloom, and politicians know that they will feel the electoral wrath of unhappy consumers in the 2010 midterm elections if the economy does not improve.

But the realignment of the American economy is still in the early stages. The industries that led the charge during the credit bubble must continue to shrink, and new, healthier, and more useful businesses must develop to take their place. Millions of consumers will have to continue to pay down their debts, meaning lower levels of consumption, and thus slower economic growth over at least the next two years. A healthy economy relies on steady job growth and rests on sound finances. The job market, and consumer balance sheets will not recover for quite a while. The optimism shown in the latest sentiment numbers is premature, and based on false assumptions. The mess created by years of reckless spending has created a mountain of debt that will take a long time to work off. So, please do not be fooled by glimmers of less than horrible economic news, or by false declarations from elected officials regarding the soundness of critically ill industries.

I wrote about this topic a few weeks ago in a piece called “Still Heading for the Abyss,” please check it out!

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