Governments four year austerity programme will not work unless people feel safe to spend money again. Even then they may not spend as compulsively as before.
In our Celtic Twilight, the lights will be dimmed, not to be turned up again for a long time to come. Consumer sentiment is one measure of just how dim they have and will become. How safe or vulnerable we feel both predicts and causes changes in consumption behaviour. As billions are sucked from the economy to shrink the gap between what is paid into and out of the public purse, the cure for economic woes may turn the lights too far down and undermine recovery for years to come.
In recent commentary the ESRI warned of a deflationary spiral should consumers and businesses pull too far back from spending. Acutely aware that more pain is to come from a hair-shirt austerity programme, people are budgeting to spend less and save more.
The link between positive sentiment, wealth and consumer spending is well understood. This positive wealth effect, seen more with increasing housing prices than increasing financial asset values, is understood to directly affect consumer behaviour. The wealthier we feel the more we spend and the less we save. And young people tend to spend more than older people. We spend more as we believe our earnings will continue to grow – we expect our future incomes will finance the costs of our current consumption. While some peoples’ mental accounting has them budget to live comfortably within monthly income, others spend to live within their anticipated income. It some it triggers compulsive consumption.
Household liquidity, unlocked using bank credit, fuels spending which in turn fuels growth and rising incomes. This positive multiplier lulls people into a false sense of security. Collapse asset values and deflate income expectations and a negative multiplier causes deflationary spirals lasting years. Should governments strip liquidity through taxation and reduction in spending then a tipping point is reached beyond which deflation undermines any chance of meaningful growth. Taxation revenues shrink, requiring further borrowing pushing nations towards default.
Here we have treated housing as both a store of wealth and a tradable financial asset to be tapped into to fund lifestyle costs. By late 2007, households held over €330bn in financial assets (shares, pensions & savings) with houses worth about €630bn. With €200bn of household debt, of which €140bn was in mortgages, housing equity was about €490bn.
It was the high tide mark of a compulsive consumerism fooled by expectations of ever rising incomes. No more so than a younger generation, the under 35’s, who borrowed more and saved less then any previous generation. Abundant cheap bank credit delayed the inevitable pain of paying for lifestyle purchases. Our national love affair with property as a store of liquidity and tradable financial asset treated homes as cash horde to be tapped into at will. But it was illusory liquidity that could only be unlocked by using bank credit. A dangerous mix of consumer’s compulsive consumption and bankers compulsive gambling created an illusion of wealth and household liquidity that in turn fuelled higher levels of spending.
Within three short years total housing wealth has imploded. The positive income expectation that was an impetus to spend more has become a negative expectation of increasing financial vulnerability causing us to save more. No one knows what the deflationary impact of a massive reduction in household wealth allied to fears for the future, higher marginal taxation rates, declining real incomes and shrinking numbers at work will be. We may still be worth about €520bn but as we still owe €200bn, we feel a lot poorer.
With careers stretching in front of them, younger people spend more and save less. As vanguard lifestyle consumers, their positive sentiment and willingness to spend fuels economic growth encourages business to invest, creates jobs and swells the public purse.
Relative to others we have a larger percentage of younger people whose wealth and liquidity has all but evaporated. Many owe far more than they can ever hope to repay. With the amount of take home pay required to finance debt escalating, they are now caught in a deflationary spiral. The adverse psychological effects on a generation of young skilled professionals both employed and unemployed may cause a permanent shift in behaviour to precautionary saving and prudent spending. There may be no returning to compulsive consumerism.
By unlearning compulsive consumption habits and relearning how to prudently budget, people will probably spend far less and save more of their disposable income for a long time to come. Has this shift to pragmatic value seeking consumerism been factored into economic planning?
The Government’s austerity programme will act as a black hole sucking in a large chunk of what’s left of household wealth and liquidity never to be seen again. Should it dim the lights too far, fatally undermining what confidence remains then ESRI warnings will come to pass. The Celtic Twilight may become a far darker place and last far longer than it’s being planned for.
A version of this article appeared in the Irish Examiner, Business Section Monday 25th October 2010.
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