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How Long Can Over-Leveraged Consumers Prop Up the Economy?

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Earlier this week, Spencer Schiff wrote an article noting the importance of consumer spending to the US economy and the consequences that will follow if Americans suddenly tighten up their wallets.  Schiff isn’t alone in his concern. A mainstream economist sounded a similar warning during a recent CNBC interview.

In his article, Spencer pointed out the US economy’s dependence on consumer spending.

The recent emergence of widespread economic weakness leaves consumer spending, which makes up approximately 70% of our GDP, as a crucial pillar supporting the current expansion. In fact, besides government outlays, it was the only major GDP component that contributed positively to growth in Q2. Clearly, any shift in consumer psychology/behavior could knock a critical support out from under our economy.”

In fact, there are already signs that this could be happening. Consumer sentiment is falling, as Schiff noted.

Now it appears the mainstream has picked up on the risk involved in basing an economy on consumer spending and consumption. During a CNBC interview, economist Jim O’Neill said the US economy is becoming “riskily dependent” on the “overleveraged consumer.”

The economy’s strength … depends so much on consumption, which is fine unless financial conditions tighten unexpectedly when a lot of indebted US consumers won’t be able to afford to keep up the consumption their doing.”

O’Neill said in some ways, it’s a lot like 2008.

His comments become more poignant when you realize that much of the consumption over the last several months has been charged to credit cards. In effect, US consumers are propping up the US economy with money they don’t have. Total outstanding consumer debt surged over $4.1 trillion in the second quarter of 2019. Over the last 12 months alone, American consumers have piled on an additional $208 billion of debt.

Revolving credit – primarily credit card debt –  increased at an annual rate of 5.3% in Q2. Americans currently owe $1.07 trillion on their plastic. This was a record for a second quarter and was only topped by the “holiday shop-and-borrow” season in Q4 2018.

Yes – Americans have been spending money, but they’ve been spending borrowed money. That’s all well and good until the credit cards become maxed out. This is the epitome of “unsustainable.”

Spencer wrote that deteriorating consumer sentiment could lead Americans to begin saving in order to prepare for an economic downturn.

Between blaring headlines on cable TV banners, newspaper articles, and social media posts, Americans are being inundated with dire economic warnings. With the horrors of the Great Recession still fresh in their memories, they’ll likely begin to prepare by reducing their discretionary spending in order to accumulate savings.”

And of course, they’ll want to start paying down some of that $4.1 trillion on debt.

This may already be happening among the rich. According to a CNBC report, “The rich have cut their spending on everything from homes to jewelry, sparking fears of a trickle-down recession that starts at the top.”

Luxury real estate is having its worst year since the financial crisis. Sales at art auctions are down for the first time in years. Retailers that cater to the wealthy are also struggling. Barney’s has filed for bankruptcy and Nordstrom has posted three quarterly revenue declines.

According to CNBC,  “recent data suggest that the US wealthy are beginning to shut their wallets.” Meanwhile, “savings of the rich has also exploded, more than doubling over the past two years, suggesting that the wealthy are hoarding cash.”

This is exactly the scenario Spencer describes. And it would make sense that it would start with the wealthy since they tend to be more attuned to what’s going on in the economy. They didn’t get rich by being dumb with their money. The fact that the rich have shifted from spending to saving could be a canary in the coal mine.

As Spencer wrote, “It may soon become apparent that consumer spending, currently our primary recession deterrent, has ground to a halt. If so, a serious economic downturn awaits.”

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