If you are like myself, you might find your market forecast changing with every article you read or TV show you watch. We are constantly being bombarded by complex analyses that tend to be biased and, honestly, pretty confusing. Using syllogisms I am going to build a concrete equation that can, in very simple terms, explain today’s market and how it is replicating the cause of our initial recession in ’07.
To be blunt, a full recovery (this year) is not possible. With the amount of debt the consumer is still holding onto, the economy can only be doing this well because of artificial factors. Some Debt Numbers: Seasonally adjusted consumer debt peaked at 2.519 trillion dollars in ’07. Currently consumer debt is 2.472 trillion-only dropping about 2%. The DSR (ratio of debt payments to personal income) at its peak in ’07 was 13.90, it is now 13.11-about a 6% drop. This leaves around 98% of the debt which got us into this mess still lingering in the economy; the consumer, as a whole, is not able to pay off about 94% of that debt.
First, how we got into this situation:
In ’07 the economy witnessed a debt bubble pop. The bubble was created with the new ability consumers came to possess in the late 1900’s, called paying with credit. This massive credit explosion pushed the economy to new heights. In order to keep up with consumer purchases, new businesses were created, and established businesses grew exponentially. When consumers began to default on their credit in ’07, the economic climb hit a wall and began its decent. So what happened?
Lets first establish our equation:
A consumer makes purchases based on what he “needs” and what he “wants”. Both “needs” and “wants” are established by the spending power of the consumer. (A consumer cannot buy what his money does not qualify him to buy.)
From this we get:
Purchases = (Needs + Wants)
where (Needs + Wants) = Spending Power
Which results in the equation:
Purchases = Spending Power
Purchases are also related to the size of the market. When consumers buy more (demand) the market will grow to meet that demand (supply). It is the basic supply and demand theory: consumers asked for more to buy (demand), businesses responded by expanding (supply). For example, if consumers asked for a million bushels of corn when only one farm existed, more farms would be made to meet the million bushel quota the consumers asked for.
This shows us that:
Purchases = Demand
and
Businesses = Supply
...Purchases are the demand to the supply of businesses:
Demand = Supply
Purchases = Business
This brings us to the economic concept that the amount of businesses in the economy are related to the amount of spending power the consumer has as a whole.
Purchases = Business
Purchases = (Needs + Wants)
(Needs + Wants) = Business
Resulting in the main equation of this article:
Business = Spending Power
How Credit Effected The Equation:
The ability to use credit allowed the consumer to use more spending power than it possessed, creating a “false spending power. This “false spending power” increased the “needs” and “wants” of the consumer, resulting in the creation of more, and larger, businesses:
(Credit) + (Spending Power) = False Spending Power
Using the same substitution as above:
False Spending Power = Inflated Purchases
Inflated Purchases = Inflated (Needs + Wants)
Inflated (Needs + Wants) = Business Inflated by Credit
Our main equation with credit involved:
False Spending Power = Business Inflated by Credit
The Bubble Pop:
In the years leading up to the ’07 market crash the consumer’s use of credit was inflating their purchasing power, and this created a false demand (as shown above). In order for supply to meet this false demand more businesses were created and existing businesses grew larger. When the “false demand by credit” was exposed in ’07 the equation became uneven.
To Clarify...
The main equation during the bubble build up:
False Spending Power(Demand) = Businesses Inflated by Credit(Supply)
The main equation after the bubble popped in ‘07:
Spending Power(Demand) < Businesses Inflated by Credit(Supply)
The “Spending Power to Businesses” equation, like all supply and demand equations, began to equalize itself when the economy realized it did not have as much demand (spending power) as it thought. Since the average consumer cannot simply create their own money, the “spending power” side became fixed which put downward pressure on the “businesses inflated by credit” side of the equation. This is when companies started to see huge drops in earnings. Consumers were not able to buy what they used to and supply was too high, thus exposing the economy’s overabundance of businesses. Now, a business surplus that is being pressed down results in contractions and bankruptcies.
Why Does it Seem Like a Market Turnaround is in Sight?
-Because the government took credit’s place in the equation:
Before government intervention:
Spending Power < Businesses (Still too high, but slowly shrinking)
Which should bring the economy back to square one:
Spending Power = Businesses
But...
Luckily(?) for the consumer, the government began creating money. As it is well known, the government cannot increase spending power. They can only fool the consumer into thinking they have increased spending power by giving them more dollars to hold (when more dollars are put into the economy, the value of the dollar decreases):
Dollar = Spending Power = Dollar x More Dollars
Essentially, the government feeds dollars into the economy, “Stimulus”, and the spending power side of the equation does not change:
(Dollar x Stimulus) / Stimulus = Spending Power
But the consumer thinks that:
Dollar + Stimulus = Spending Power + Stimulus = False Spending Power
This heightens consumer confidence, which causes them to purchase more. As we already established, businesses respond to demand by increasing production:
False Spending Power = Businesses Inflated by Stimulus
Look familiar?
In conclusion:
The problem we created can only be fixed when the economy reaches an un-artificial equality between spending power and businesses. As I have shown, the government is not treating the problem, it is just treating the symptoms. By only treating the symptoms, a falsely inflated market is-once again-being created. Thus, our economy is not much healthier then it was during the debt build up; expect to see a repeat of the ’07 recession in the near future.
Get ready for a fun ride.
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