Thursday, October 15, 2009

Let's not forget that this is a balance sheet recession

Everyone wants to compare this recovery to past recoveries which have followed V-shaped recoveries. Fast in and fast out is the new buzz, yet we have to remember that the key issue that differentials this recession is the horrible balance sheet of consumers. We need to see improvement in this area to create an environment for stronger growth. The increase in the stock market certainty is providing gains in wealth but there are broader measures that need focus.

One simple measure is the ratio of liquidity assets to liabilities. This has started to improved but the numbers have been stretched through a strong decline from 2002-2007. When consumers were using their homes a piggy banks, they let the cash balances fall relative to liabilities. As wealth was added, the need for cash declined. At lower wealth levels, cash balances have to increase.

Consumer credit is still in decline and still shrinking. This is good for the repair of the balance sheet, but it also means that consumers are not going out and buying goods. The decline in consumer credit is stronger than the decline in retail sales, so households are trying to repair their balance sheets. This can be a good longer-term sign.

Household liabilities also have fallen but this is not just due to the paying down balances. Foreclosures and bankruptcies are also reducing the liabilities.

Corporations are actually behaving like consumers. They are all repairing their balance sheet which explains why corporate profits have not fallen as much as initially expected and why there has been little hiring. Full time workers are a luxury. Corporation have also borrowed close to $700 billion this year to restructure and hold higher cash. They do not want to be caught in liquidity crunch.

Focus on the balance sheet repair if you want to get a good idea of the potential for a strong V recovery.

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