The consumer recovery is a fiction

Paul Raven @ 19-08-2009

bankruptcy sale signs - tough times at Circuit CityAs Tom has set the tone already, how’s about some more economics?

This one’s even bleaker than the prospect of another bubble in the pipeline: John Robb explains why the consumer recovery being trumpeted desperately by newspapers everywhere is, at best, wishful thinking:

The driver of this fragility is that 75% of a typical American families budget (not counting education costs of kids) is dedicated to fixed expenses. This means that the loss a small as 10% in a family’s income would be sufficient to force failure. Combine this fragility with increasing income volatility and even the slightest shock will set off a wave of extreme frugality and mushrooming financial failure at the household level. In the past, we were able to hide this fragility through increased debt/bubbles. That’s over. We’ve already taken on as much debt (375% of GDP right now, and still climbing) as we can acquire and the banks are hoarding the bulk of federal cash infusions to paper over their insolvency (almost all of the toxic assets from last fall’s debacle are still in place, and more are en route from commercial real-estate).

Part of me would like to think Robb is wrong, but his ideas – and those of other outsider analysts like him – have the ring of truth about them, simply because they’re the only people who aren’t telling us what we desperately want to hear (which just so happens to be what governments and economists want us to believe).

Meanwhile, TomorrowMuseum points to an article at the Wall Street Journal that attempts to “remove the stigma of bankruptcy:

As long the economy stays grim, bankruptcy filings will become increasingly common – which may diminish the stigma that accompanies bankruptcy. It is, in a sense, surprising that so many Americans should still feel ashamed of bankruptcy when those in a far more comfortable situation feel no such chagrin. Corporate bankruptcies are an accepted part of doing business from Wall Street to Silicon Valley. Executives who collect $30 million from a bank in the years before it collapses are not expected to give it back.

Most striking to me as a European, though, is this bit at the beginning of the essay:

… too many people are talking about bankruptcy as if it’s a sign this country’s social safety net has failed. It isn’t. Bankruptcy is part of the safety net. Other countries have welfare states, America has bankruptcy.

Now, I’m no economist, I’ll freely admit… but from where I’m sat that sounds like something the Queen of Hearts might have said if Alice in Wonderland had been a satire on economics. Either that, or a contender for Panglossian statement of the decade. [image by quinn.anya]

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3 Responses to “The consumer recovery is a fiction”

  1. Anandas says:

    It’s absolutely true that bankruptcy is a safety net. Not only that but it’s a societal good, because of how our monetary system works. Why? Because the money supply grows via the creation of debt. If people start paying down the debt en masse, the money supply shrinks! But if that happens we get massive deflation. But to counteract that the banks issue even more debt, until it spirals up to the point there is no hope of ever paying back all the debt in existence, which is also the money supply.

    The only ways out of this are to issue money that doesn’t need to be paid back as debt (which could lead to hyperinflation) or widespread bankrupty, which cancels the debt and allows the existing money in the system to finally circulate debt-free.

  2. Paul Raven says:

    I’m sure you’re right, Anandas, but it still sounds utterly insane… 🙂

  3. antares says:

    It sounds insane to you because you are British. In the UK and Canada, bankruptcy means the end. The business goes into receivership, assets are liquidated, creditors are paid according to law (usually pennies on the dollar), and the doors close. I do not know how personal bankruptcies are conducted in the UK and Canada, but my legal contacts tell me it is something to avoid.

    In the US, bankruptcy is a Constitutional prerogative of Congress. For most of American history, there was no federal statute and the several states enacted insolvency laws. For many citizens, however, the remedy lay in the frontier — move. Davy Crockett left his home for Texas to escape creditors.

    In 1898, Congress enacted the first comprehensive bankruptcy bill. It was called the Bankruptcy Act. In 1976, Congress replaced the Act with the Bankruptcy Code. Since its enactment, Congress has amended the Code many times.

    The US has the most sophisticated bankruptcy laws in the world. Chapter 7 covers liquidation — what every non-American thinks of when he thinks of bankruptcy. Chapter 11 covers business reorganization; it allows businesses to continue to operate. Continental Airlines has been through several reorganizations. Chapter 13 covers non-liquidation personal bankruptcies. Both Chapter 11 and 13 bankruptcies requires creditors receive some payment. Other chapters cover special instances — government entities (cities, water districts, and such), family farms, and more.

    Of great interest is that businesses may pursue legal remedies while under bankruptcy protection. I have known a business that was successful in its suit against Microsoft and paid off 100 cents on the dollar to creditors at the end of litigation. (Let me know if you find this case. Microsoft petitioned the court to seal the records. The case appeared in the bankruptcy trade papers but cannot be found in the casebooks. The plaintiff was a hardware firm in Albuquerque. I mentioned this at a Linux meeting and all the geeks knew who, when, where, and what.)

    Bankruptcy means something different on the American side of the Atlantic.