LEVERAGE
AND THE IMPACT OF SLOWING ECONOMIC GROWTH
by Joseph Dancy,
LSGI Advisors, Inc.
Adjunct
Professor, SMU School of Law
August 5, 2004
Spending
by U.S. consumers account for two-thirds of our economic growth, and a
slowdown in consumer spending is quickly apparent in the economic
statistics. In fact, recent GDP data indicates consumers are slowing
their spending - possibly in response to increases in the cost of
gasoline and electricity which has reduced their disposable income.
Last month’s GDP data indicates consumer spending rose at a 1% rate in the second quarter, a mere shadow of the 4% first-quarter gain and the most sluggish pace since the second quarter of 2001 when the economy was still in recession. Most economists were surprised at the slowdown in consumer spending, and blamed it on the “big energy price rises” which meant consumers had less to spend on other goods and services.
We want to address the issue of consumer spending because some experts have noted that consumer debt levels have grown to levels they think are unstable – and that a small rise in interest rates could bring the economy to a halt. As the chart above indicates household debt has continued to grow over the last two decades, and we now sit on a $10 trillion mountain of household debt according to Federal Reserve data published last month.
In
addressing the issue of consumer debt Stephen Roach, chief economist
at Morgan Stanley, noted "This has all the ingredients for
disaster. It will take nothing short of a miracle to extricate the
self-indulgent American consumer from this mess."
Other experts point out that strong consumer spending seen the last few years was the result of a conscious policy choice made by the Bush Administration: tax cuts from federal government and low official interest rates from the Federal Reserve. With the Federal Reserve now raising interest rates and many tax cuts already in place, the policy options to counter economic weakness might be limited.
Unfortunately, as Long Term Capital Management discovered the hard way, the use of leverage and high debt levels can make financial systems unstable – and can exaggerate trends both upward and downward. With the higher energy prices we expect consumer spending to slow, and the high consumer debt levels concern us. Ultimately, lower consumer spending will adversely impact the economy and the stock market – it is just a question of when.
© 2004 Joseph Dancy
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Oil & Gas Law,
SMU School of Law
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