Businomics Blog

Consumer Attitudes: The Future of Saving and Spending

This recession has shaken people up, but what will be the lasting effects on consumer behavior?  That's one of the key questions as we look forward at the nature of the recovery.  I've been arguing for a "return to normalcy," in which people will abandon the exuberance of the boom, but without going overboard into miserliness.  However, some folks are looking for a return to Great Depression-born attitudes toward thrift.  So let's look at the savings rate in the Great Depression and afterward.

The Great Depression: The savings rate was fairly low.  With incomes down, people couldn't afford the luxury of saving.

World War II:  High savings rate due to rationing and price controls (goods were not available for purchase), which continued through mid-1946.

Early Post-War Years:  Savings rate low, as consumers used their accumulated savings to buy the newly available consumer goods.

1950s, 60s and 70s:  Normal, stable savings rates return after the gyrations of the Great Depression and World War II.  Notably, savings rates rise the farther away from the Great Depression we move!  A thorough analysis requires a look at demographics, because savings is very age related.  So there may be a Great Depression effect, but it certainly is not so large as to be obvious.

1980s, 90s and 2000s:  Declining savings rate.  Why?  Perhaps a more reliable social safety net reduced the need for savings, perhaps social attitudes toward near-term satisfaction versus long-term risk were changing.  However, it certainly was not demographic change.  The baby boomers were advancing into their high-earning years, which are typically high savings years, so the savings rate should have risen, if nothing else were changing.  Also, the officially calculated savings rate undercounts investment income, thereby underestimating savings.  (It's complicated; more details here.)  Some argued that our savings rate got so low because people assumed that their home appreciation would do their savings for them.  However, the savings rate declined steadily through the 1990s, when home price appreciation averaged only three percent per year.

The Great Recession:  The chart above with annual data through 2008 doesn't show recent changes very well.  Here's a picture with quarterly data through the third quarter of 2009:

You can see the savings rate has jumped recently.  (The data are jittery because of the 2008 stimulus payments and the recent Cash-for-Clunkers program. Also note that quarterly data are only available back through 1959.)  This is really the key to our recession: consumers got scared and stopped spending.

The Future of Consumer Saving and Spending:  I think consumers may well return to a higher savings rate.  However, I don't see any justification for them moving their savings rate up any faster than they moved it down.  Aside from the World War II, experience, sharp moves tend not to last.  The big changes are gradual.  So let's suppose that consumers want to get back to an eight percent savings rate.  What does that mean for actual savings?  From 1982 through 2005, the savings rate dropped by eight percentage points over 23 years, or about 0.35 percentage points per year.  That means that consumer spending would, in the future, grow by about 0.35 percentage points slower than incomes.  We could well expect the average gain in disposable income in the coming years to be about five percent, so look for spending growth of maybe 4.65 percent. 

The big lesson: consumers can raise their savings rate without going into a bunker mentality.  They'll still grow their spending, just at a slightly slower pace.  That's positive for the economic outlook, because we need consumer demand in the near term to help the economy get going.

As I've noted before, companies selling to consumers (or in the consumer goods supply chain) should monitor their sales very closely, not only in the aggregate but also by price point.

Lessons of the Financial Crisis from Bill Dudley

I recommend a recent speech by my old classmate Bill Dudley, now president of the Federal Reserve Bank of New York:  More Lessons from the Crisis.

The reading is a little ... assumptive of some familiarity with financial markets.  (Some casual readers might call the prose dense, but it's not really aimed at the casual reader.)  However, it's excellent in its explanation of financial crises, doing for the modern era what Walter Bagehot did for the 18th and 19th century period.  (If you have some time this holiday season, read Bagehot's Lombard Street, either online or via Amazon, but avoid the Dodo Press version, which is riddled with typos.)

Dudley explains the risks that arise from the investment banking sectors.  When he describes possible regulatory actions to deal with these risks, he does something unusual: he acknowledges the costs of regulation:  higher costs of financial intermediation and moral hazard.

Hacking in the Public Interest: 5 Ways to Protect Yourself Early

OK, you may not think that the capture and public posting of thousands of climate change emails and datasets constitutes "hacking in the public interest."  (More on that story in the New York Times.)  But the folks who did the hacking apparently believe they are serving the public interest.

You may give little credibility to a few sentences taken out of context, sifted from thousands of emails.  But the public sees the sentence and thinks, "That liar!"

What about you?  Are the animal rights advocates hostile to your business?  Is a union trying to organize your company?  Does your firm offer domestic partner benefits?  If you are involved in a controversy--even if you are trying hard not to be controversial--consider the possibility that people with strong positions on the issue may try to hack your computers.  What can you do?

1.  Review your computer security procedures

2.  Remind your staff members that they are to obey all laws and company policies.

3.  Remind your staff members that email is a written, permanent record.

4.  Don't trust routine document destruction protocols.  There are too many backups that can be subpoenaed to protect you from incriminating documents.

5.  Plan for a public relations disaster.  If your staff members are busy getting their jobs done, they will write something that will look bad when taken out of context.  It's unavoidable.  (Full disclosure: my hard drive is full of politically incorrect jokes, cartoons, and caricatures of stupid politicians.)  Have your PR people outline their plan for the publication of embarrassing information.  You may not know what embarrassing information will surface, but something will.

Selling a Business on a Note: 9 Tips for Success

One of my favorite boat supply online stores has closed, and the story is worth repeating to all business owners.  The founder of this company sold the business and took a note as partial payment.  The new owners have defaulted on the note, closed down the business, and the old owner is now facing re-opening the shop to recoup some of the money he should have been paid.

The same thing happened to a friend of mine who sold a business a few years ago, and he's now behind the banks in priority to get paid from the few remaining assets of the business.

Before criticizing the practice, remember there are good reasons for the sale of a business on a note:

1. Seller financing increases the number of potential buyers
2. Seller financing increases the likely purchase price (assuming the buyer pays off the note!)
3. Seller financing give the seller a stake in the success of the new owner, which is likely to help with transition issues.
4. Seller financing signals to the buyer that the owner is confident that the business will succeed under new ownership.

The downside, of course, is the the seller gets a note rather than cash.  Here are some steps to take to reduce your risk when you sell the business:

1. Get a substantial portion of the price in cash up front.  If you don't, you are merely giving away an option, not selling the business.
2. Ask yourself if the buyer really does have the skills and temperament necessary to succeed.
3. Run a credit check on the buyer.
4. Ask if the buyer has other assets that can be pledged to secure the loan.
5. Set up some loan covenants, such as the buyer needing to maintain a certain level of working capital or a particular level of net worth.  That allows you to step in early if the business starts going downhill.  (You may need to ask a banker for advice; they do this sort of thing all the time.)
6. Demand regular audits to ensure compliance with the covenants, and also that the business is being run honestly.  If you need to take the business back, it's imperative that you not have to clean up ethical issues left behind by the buyer.
7. Stay in touch with major customers.  Know if they are unhappy or cutting back their orders.
8. Sketch out a contingency plan for taking back the business.  There may well be some simple things that will help you if worse comes to worst.  Think it through ahead of time.
9. Do not sail around the world, trusting that all will turn out well (unless you can afford to walk away from the unpaid balance on the loan.)

Oh, and if you need sailboat parts, check out my other favorite on-line merchant: West Coast Sailing.  They are definitely still in business and providing excellent service.  Tell George I sent you.

Six Tips for Business Planning in an Economic Recovery

Rich D'Amaro, Chairman and CEO of Tatum LLC has offered "Six Tips for Business Leaders to Consider as We Emerge from Recession."  I especially like his first suggestion:

Identify and Maintain Your Strengths, and Your Best Customers

Many businesses have limited working capital today, but they need to make the sales calls, stock the inventory, and be ready to gear up production when orders increase.  Knowing which segments of your customer base are most important is critical to good utilization of your limited working capital.

Rich's other suggestions are OK, but I think he misses the biggest need: a company survey that I call a Recovery Readiness Audit.  As I probe in detail within a business, I find numerous areas in which they are not really prepared for what happens when their customers and prospects start to spend money.  In some places the sales people are not calling on prospects, in other locations they are not laying the ground work to ramp up their production workforce, and in many cases the company has not carefully estimated cash drains when they have to buy raw materials and rehire workers.  This review should happen IMMEDIATELY.  (And I can help, if you want an outside pair of eyes looking at your operations

Job Seekers: There's Hiring Going On!

There is a surprising amount of new hiring going on.  That may seem strange, given the job losses in the economy, but the widely-quoted figures show net job growth.  An unemployed person does not need a net new job, he or she just needs a job.  Here's an illustration.  (Inspired by a chart in Forbes Magazine.)

The blue section of the chart shows hires, counting all hires for any reason: new position or replacement of existing worker.  The red shows all layoffs, firings, quits, and deaths of working persons.  The net change is shown in black, and that's the headline figure. 

Even though unemployment is high, there is hiring going on every day, all across America.  More good news for job seekers: a lot of the unemployed are so discouraged they are not making a particularly strong job search effort.  That gives a leg up to the unemployed who pound the pavement and make the calls.  As I said in a recent newspaper interview, the first wave of employment growth will go to those people who do the best job of pretending not to be discouraged.

Tight Inventories Limiting Sales

Business have trimmed inventories significantly--and that's starting to bite them in the sale.  Here's the raw data:

There was good reason to cut inventories: sales were falling.  This is a recession practice I recommend in Businomics.   However, the tight inventories are now limiting sales gains.

Here's a personal example.  I bought a car last spring, and now I want snow tires and wheels for it.  But the tire store I love did not have my size in the type of tire I wanted. 

(You may be surprised that anyone would love a tire store, but if you live in the Pacific Northwest, you know who I'm talking about.  I have been a very, very loyal customer for 20 years.  I don't comparison shop other stores, I just to in and buy.)

So my fav store lost a sale.  I went elsewhere.  No deals to be found, so some sales are probably not going to anybody at all.  By the first real snowfall, there will be no studless snowtires to be found anywhere, despite people clamoring for new tires.

From an economic standpoint, this will limit economic growth.

From a business standpoint, my favorite store has double whammied itself.  First, it lost a sale.  Second, it gave me a reason to go to a competitor.  That's like telling your girlfriend she should date other guys--not a way to build a strong relationship.

I know money is still tight, the economic outlook is still uncertain, but if you cannot serve your loyal customers, you will have no loyal customers.

Economic Forecast for 2010: Updated November 2009

I've updated my economic forecast for 2010.  Here's a chart showing quarterly growth rates:

Key features: consumer spending on durables dips this quarter (after cash-for-clunkers), then grows at a pace that mixes conservative attitudes with pent-up demand and limited credit availability.  I spent more time this round modeling inventories.  It's still a big wild card, that can swing quarterly numbers hugely.  For instance, an optimistic--but not implausible--figure for the change in inventories this quarter adds another 1.5 percentage point to GDP growth.

This growth rate is well above productivity growth, so we'll make progress lowering the unemployment rate.  Note huge, sudden progress, but gradual improvement.

I'm assuming that the Fed will slow it's stimulus, preventing an upside breakout.  With this in place, the inflation rate should be tame.

This is strong enough growth that businesses should conduct a Recovery Readiness Audit, that surveys all issues tied to business expansion: sales, operations, finance.  I can help your company with that; give me a call.

Bank Credit Standards: The Tightening Is Over

Banks have pretty much stopped tightening credit standards, but that doesn't mean they are easing--maybe not, at least.  The chart below is based on the Federal Reserve's Survey of Senior Loan Officers.  The question asked is whether they tightened or eased credit standards.   The chart shows "net percent," which is the percent who said that tightened minus the percent who said they eased.

In this survey, as in recent surveys, no one said he had eased.  It's all tightening or staying the same.  Nonetheless, the chart clearly shows the worst of the tightening is over.  Also note how few banks ever admit to easing credit standards.  We know credit was eased tremendously in the mid 2000s, but that hardly shows up in the chart.  Talking about tightening makes better conversation with one's regulators.

Unfortunately, the data don't allow us to calibrate where we stand now compared to, say, 2003.  We know that a lot of tightening was justified to get past the easy credit of the boom, but it is hard to say whether the banks have gone overboard and over-tightened.  Maybe, or maybe they've just returned to a moderate stance.

The other issue that we don't fully understand: when banks say they have tightened credit standards, to what extent are they merely reporting that nobody meets even the old standards?  Remember that most bank loans are real estate related.  A bank that kept its lending standards unchanged might very well be making few loans today, because so few real estate development projects pencil out.

What does this mean for borrowers?  First, run more cash flow projections than you ever have before.  Consider a second drop in sales, consider a moderate increase in sales, and a major increase in sales.  Get an idea for which scenarios put you short of cash.  (Hint: you may run short of cash if sales fall, or if sales rise sharply.)  Second, talk to your banker early about potential cash needs.  It's never good to surprise him or her.  If your banker will not be able to help you, start looking at alternatives real soon.

Another Good Economics Book: The Price of Everything

I've been hard put to recommend an economics book aimed at the layman, because I don't read many of them myself.  However, here's a wholehearted recommendation: Russ Roberts's The Price of Everything.  The book is written as a novel, though with lots of didactic conversations.  The book conveys very well how the economy really works. 

I confess that as a young professor, I emphasized the analytical tools that were complicated and neat.  Those would allow the student to eventually understand how prices coordinate production.  Roberts gets right to the heart of the matter, without the graphs and equations that I used to love to teach.  What's more, he adds the insights of Hayek, Nobel-winning insights that turn out to be far more important than the technical parts of economics.  Along the way, Roberts weaves in an interesting little mystery with interesting characters.

I bought the book as a birthday present for Mrs. Businomics, who has picked up a lot of economics through proximity, but has asked for a basic read on the topic.  After she finished it, I picked it up and really enjoyed it.

The other good economics books I've written about:

Don Boudreaux's 10 favorite economics books.

Greg Mankiw's reading list, with a few of my comments thrown in.

My comments on two books that appeared on Mankiw's reading list.

If you want to connect the dots between economics and your business decisions, also check out Businomics: From the Headlines to Your Bottom Line--How to Profit in Any Economic Cycle.