The Long Tail of the Credit Crisis - 04/14/10

I would have to bring the recommendation to the board that said, you don't have the money to keep these people hired or at the same level of pay or compensation. That we might not even be able to continue to operate a five-day school week or summer program programs or sports at all.
-- Superintendent Michael Lannon, St. Lucie School District (April 13, 2010)

While large corporations are well positioned financially and operationally (see Intel (INTC)), one of my main themes regarding the shape of the domestic economic recovery is that the plight of the state and local governments will weigh adversely on the slope of aggregate growth.

Yesterday the St. Lucie (Florida) School District announced that next year's budget will face large shortfalls and that large cuts are being contemplated including "closing two schools and implementing a 'pay to play' program for sports."

To be sure, there will be no "congratulations and great quarter, guys" at the next St. Lucie School District board meeting. And the lack of confidence and uncertainty that this nontraditional headwind presents helps to explain part of the weak NFIB Survey of Confidence discussed yesterday and the continued weakness in mortgage applications (reported this morning).

For now, the profits results and strong balance sheets of large corporations (in the S&P) have taken center stage for investors -- small-business and consumer issues are backstage and unseen. But there will be a tipping point when weakness in small business and the consumer begin to affect the demand for those larger corporations' goods and services.

As I have written on this subject previously:

If we look at past cycles, businesses have consistently been the driver of consumer incomes and spending. I learned in my economics classes at Wharton (like Karen Finerman) that this phenomenon is known as Say's Law of Production. Say argued:

1. against claims that business was suffering because people did not have enough money and more money should be printed; and
2. that the power to purchase could be increased only by more production.

But -- and this is the big BUT -- over the last century, the consumer was in far better health than today.

Consider the following facts:

• In the past, corporations didn't engage in the draconian cost-cutting that they have embarked on in the past several years.
• Globalization wasn't the mainstay condition that it is currently, so previously we didn't see the wage deflation and the magnitude of the decline in disposable incomes present today.
• Finally, consumers were not as tightly wound and leveraged in any of the previous cycles. Just look at the record level of household debt relative to incomes that exists today.

As a result of the above factors (and others), the U.S. currently has 10% unemployment, and if you count in part-time workers that can't get full-time jobs and those that have given up looking, the number almost doubles to one-fifth of all Americans. The consumer is in dire straits, and, for the first time in history, it is the consumer that is going to drive business' growth, expansion plans and confidence, not vice versa.

Sorry, monetarists, Say's Law might be dead.

Position: none