Monday, 2 November 2009
On consumption vs business investment
Interestingly, hardly had I pushed the "publish" button for my post on Friday before the markets went into a tailspin. The story was the same as I have touched upon a couple of times in recent weeks, namely the role of consumer spending in the recovery.
On Friday, both Germany and the US reported that consumer expenditure had surprisingly fallen in September. The concrete numbers are probably likely to be changed in due time, but the damage was done and serves as a timely reminder about the uncertainty still haunting the markets.
My point of view remains unchanged. The consumer did not lead us into this downturn, and it is unlikely that the consumer will lead us out of the downturn, either. The downturn gained strong momentum because business managers across the world hit the stop button under the carpet bombing from news media covering the US banking crisis.
It is obvious that without the return of the consumer confidence and spending, this recovery will remain rather anaemic. Alone the weight of consumer spending in the composition of GDP is a guarantee that there will no return to robust economic growth if the consumers remain focused on saving money instead of spending.
This does not change my basic point, namely that the economy is in fact able to pull out on the recession by growth generated in two other subcomponents of the GDP, Business Investments and Government Expenditure.
As for the latter, we know that economic stimulus programs are beginning to work their magic from Beijing over Moscow to Berlin, Paris, and Washington. Depending on the relative size of the public sector in the economy this will have some positive effects in the coming quarters.
Which leads us back to the business investments. Traditionally the smallest part of the GDP, it is also the most volatile part (well, together with the residual known as inventory investments, that is). The beginning of this downturn was no different from any other downturn. Business investments reacted quickly as business leaders hit the stop button. What was, however, different is the depth of the contraction of investment.
Business investment fell sharper than seen anytime else since the war. 1/3 or more of the business investment disappeared in a matter of a few months, leading to suspicion that business leaders did not really hit the stop button. They hit the panic button instead. The same was true for the reduction of inventories.
My point is that the most important dynamic of the recovery comes from exactly the business investments. Inventory rebuilding has already started, while still investment is beginning to focus on yet another round of productivity gains. This goes hand in hand with further job cuts, leading to a continued increase in the unemployment.
So my point about the business investment component of the GDP being the most important in creating recovery dynamics should be seen in the light of increasing unemployment. Consumers are likely to remain uneasy until they see that unemployment is beginning to fall. Whenever that will happen, probably late next year or even later.
But such fine points were lost on the stock markets last week. They were looking for economic news to feed the nervousness that had been building in the previous weeks, and they found it. In the slightly longer term, such arguments are not relevant as the consumers will eventually return to the shopping malls. In the mean time, the stock markets may end up somewhat less bullish than seen in the past months.