Deflation vs. Inflation

Money Flows

Debt Overhang Will Reduce Consumption

In the U.S., consumer spending represents about 70% of GDP. After decades of an inflationary “crack-up” boom, people are stuffed to the gills with consumer debt. But it appears that its long build-up has turned down, which is a message businesses should heed.

Many consumer businesses have already received the new message of our times: Consumers want value for their money. The days of widespread upper-end fashion and lavish dining are largely relics of the past. Don’t believe me? Take a look at charts of bebe Stores (BEBE), Abercrombie & Fitch (ANF), Morton Restaurant Group (MRT) and Ruth’s Hospitality Group (RUTH). Consumers’ changing preferences are reflected in their charts, but we’re most likely only at the forefront of decreased consumption!

A review of the past 30 years of debt/disposable income and debt service payments in the chart below shows that they still remain at elevated levels (courtesy of Gary Shilling’s Insight www.agaryshilling.com). Back in 1982, consumers averaged 60% debt-to-income and debt service payments were only 10.5% of disposable income. We witnessed a substantial rise in debt from 1994 through 2006, but that trend has been in reverse for several years now.

The massive U.S. unemployment numbers also create an interesting dynamic. Typically when one loses a job, debt will initially ramp up as the unemployed use debt to offset the lost income. But for many, the loss of a job becomes a life-changing event: Their attitude towards debt in general and the desire to consume begin to wane. So while there may only be 15 million officially unemployed, there are many more that have gone through the unemployed experience lately, which should dampen their desire to consume for years.

Will we return to the early 80s and early 90s level of debt-to-income ratios? Or will it be even worse this time? Imagine the levels of corporate bankruptcies and job losses that would accompany a decline to below a 60% debt-to-income ratio. That would mean that consumers would reduce their outstanding debt by half. Such a scenario is one of the reasons why we at EWI believe that the current recession is not over yet -- and, in fact, believe that it has only just begun.

Commercial Real Estate

Tysons Galleria operator files record bankruptcy

General Growth Properties, owner of premier malls such as Tysons Galleria in McLean, filed the largest real estate bankruptcy in U.S. history Thursday, but analysts say the move is not a sign of retail Armageddon.

General Growth, like many homeowners, paid top dollar in a rush to buy properties earlier in the decade and now finds itself awash in debt with its asset values shrinking.

The company built up $27 billion in debt during its spending spree - which included the acquisition of Columbia, Md.-based Rouse Co. five years ago for $11.3 billion - and became the second-largest mall operator in the nation.

"This is a crisis of capital," said Malachy Kavanagh, a spokesman for the International Council of Shopping Centers. "And the inability to refinance debt really doesn't have anything to do with the slowdown in sales."

The move will not affect shoppers or residents of planned communities such as Columbia, which the company manages. The Columbia property is not included in the bankruptcy filing, the company said.

"Our shopping centers and other properties will continue to offer the same great visitor experience for which our company is so well known," Adam Metz, General Growth's chief executive officer, said in a statement Thursday.

The company owns more than 200 malls, including locally the Shops at Georgetown Park and Harborplace & the Gallery in Baltimore. Other properties include Faneuil Hall in Boston and South Street Seaport in New York.

Shop owners in Tysons Galleria said they remain upbeat and credited General Growth for its management of the upscale mall.

"What they did at this mall was practically a 100 percent face-lift," said Aram Itani, owner of exclusive women's apparel store Aram Boutique.

"The ideas they implemented, the type of accounts they brought in, it just became such a beautiful center. It's unfortunate the economy is under such stress," said Mrs. Itani of Potomac.

Deflation vs. Inflation (2)

Here is a series of real (inflation-adjusted) monthly close charts of the Nikkei225 and the S&P500 since 1970 with their respective annualized rates of inflation shown below. This series also includes an overlay chart with the two index peaks aligned. The overlay retains Japan's inflation to illustrate a point discussed later in this post.

Consumer Debt

Dollar Story (6): Wave Count

SP500 Bear Percentage