Saturday, November 05, 2005
The North American Consumer: an endangered Species ?
Is the North American consumer on his way to extinction? You can all imagine the scene some 50,000 years into the future, when a group of renown paleo-anthropologists will begin excavation in a geographical area of the Eastern Seaboard known as ... The Great Wall Street Depression. They are looking for the fossilized remains of a sub-species of Homo Sapiens thought to have existed at any time between the mid-Twentieth Century and the beginning of the Twenty-First. After several days of unsuccessful research, luck strikes: they uncover the fossilized skeleton of a hominid with telltale characteristics. The large skull implies that this Homo was intelligent, the long femur is proof that he was well-fed and the gold teeth testify that he took care of himself. But what really captures the attention of the paleo-anthropologists is the fact that this specimen is still clutching a VISA with the right hand and a Mastercard with the left hand. They have unearthed the first fossilized remains of the North American Consumer !
Now that the Federal Reserve is openly on the path of war with increased interest rates and that the Bank of Canada is poised to follow suit, an important economic matter is the evaluation of the existing huge consumer debt. How much weight does consumer debt have on the economy as a whole and is the economy of the North American continent threatened by it? There is a fear these days that if Central Banks continue to increase interest rates, indebted consumers will be thrown into a tizzy and the overall result will be a sharp slowdown in the economies of both the United States and Canada. Those who believe this expect interest rates to remain at historic low levels for a very long time. At the heart of this issue is the high and ever-rising consumer indebtedness. In Canada the ratio of debt to personal income now exceeds 100 percent and in the United States it is more than 90 percent. By any standard of comparison, this is a lot of money. For instance, on the other side of the spectrum in the European Union the average ratio of debt to income is 65 percent, while New Zealand, Australia and Japan are anywhere in between on a growing scale (figures for Hong Kong, now under Chinese jurisdiction, are unavailable). It used to be that Americans were the big spenders, but they have now been outclassed by Canadians. And, furthermore, with debt growing at a rate of nine to ten percent in Canada and seven to eight percent in the United States and income growing at the rate of only two and three percent respectively, these debt to income ratios are bound to rise even further. The question, then, of course becomes: how much is too much ?
Economists have been always leery of consumer indebtedness over the past fifty years, yet disaster has eluded us so far. Canada's ratio of debt to personal income was 98 percent in 2000, which is not very much different from today. And even though interest rates were on the rise in 2000, the economy remained strong. In fact the main reason as to why consumer debt has been constantly on the rise the past fifty years is simply because credit has become more and more available. Not only did lenders in Canada - and to a certain extent in the United States - lower their qualification standards - they have also been offering a variety of loan products, thus making even easier for consumers to meet minimum monthly payments without ever substantially decreasing their debts. Lenders have even made refinancing a snap and in Canada there are reported cases of minors going around (and shopping) with credit cards boasting limits in the tens of thousands. Consumers have more financial flexibility today than ever before, and for good or bad they take full advantage of it. And this flexibility allows them to choose to carry debt when in the past they may not have had this option. Additionally, it is certainly true that low interest rates have encouraged more borrowing which, in turn, has spurred more spending. Real estate is proof of this. All the BMW's, Mercedes, SUV's we see on the streets are another proof.
But has all this extra borrowing really increased the vulnerability of consumers to higher interest rates, as it is being suggested ? Consider the extraordinary automobile deals offered by the Big Three: GM, Ford and Chrysler are offering promotions on certain models with zero percent financing for up to 60 months. As interest rates creep up, those buyers will be left unscathed for the next four to five years. The same is true for mortgages, where many homebuyers have been locking in for the next several years. This ultimately means that the return of interest rates to more normal levels will have no serious - if at all - impact on these consumers with existing debts. And save an except for tragic occurrences the likes of another 9/11 or another war, it doesn't seem that consumer spending will be abated vis-a-vis a gradual increase in interest rates. Much to the good fortune of all of us North American consumers, which do not seem to be on the way to extinction at any time soon.
Real Estate Chronicle