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22 May 2024

If things are bad, how come we’re shopping?

By Julian Bene


If the US economy is in a recession, how come retail sales went up in January? It’s a fair question and the results were not what anyone expected. Commerce Department data show retail sales were up by 0.3 per cent in January compared to December. 
A minuscule-sounding rise, perhaps, but not when multiplied by 12 to annualise the growth rate. So does this mean that despite all the gloom and doom about the housing and credit collapses, the US economy is going to soldier on? 

US Treasury Secretary Hank Paulson certainly would like to think so. He is still insisting to the Congress and anyone else willing to listen that the American economy is going to keep on growing this year, albeit at a slower pace than last year. Being optimistic is part of his job description, since if businesses and consumers think things are going to go all right they will be more inclined to spend and make it a self-fulfilling prophecy.

One answer to the meaning of the retail sales surprise is the 0.3 per cent rise covers up a big price increase in petrol. Without the increase in petrol sales, retail sales were still up, but only by 0.1 per cent. Since petrol demand is pretty inelastic, because consumers cannot or will not adjust their consumption for small price changes, it might be argued petrol station sales should be excluded if one is looking for barometers of consumer health. 

On the other hand, if consumers are finding a way to pay for more stuff, including petrol, then we are not in a downturn. On yet one more hand, consumers are not going to feel better off when paying more money for the same amount of stuff. In volume terms, rather than nominal terms, retail sales are close to flat.

Another answer is retail sales are only a portion of the economy.
Spending on services from health to haircuts is not captured in the figures. Business spending is also excluded for construction, inventory building and so on. So the economy as a whole could be down and retail spending up. However, it is not likely this could continue for long, simply because the people working in services and the business sector have to be staying in gainful employment to have the money to spend in retail stores.

So the fallback position for bears is not to believe the retail growth data altogether. There are plenty of opportunities for sampling and statistical adjustment errors in a one-month measure.

China’s exports were still rising sharply in January by 27 per cent.
That too sheds doubt on the idea the US consumer is cutting way back, since Americans are the big consumer of China’s manufactured products. Chinese imports were also way up, but the Chinese trade gap remains enormous. Increased Chinese consumption and lower exports would help the US and European economies to find their footing again. Europe’s growth numbers turned weak at the end of 2007. 


As the managing director of the International Monetary Fund again urged, China could best manage down her trade surplus by a yuan revaluation. A shift in this direction would tend to tame domestic inflation in China but boost it in the importing nations. So be it. What we have now is unsustainable. An additional approach would be for importing countries to tighten their quality standards on drugs, food, toys and other products where lax Chinese rules give rise to consumer health concerns. 

Mainstream economists do not like this idea, which they would call non-tariff barriers, because they cannot measure ‘welfare’ other than by gross domestic product figures. Why it is acceptable to regulate product quality within an economy but not to set stringent rules for imports is something they do not explain.

Ben Bernanke, Chairman of the US Federal Reserve Bank, said nothing new when he appeared before the Congress recently. He’s concerned about sputtering growth but he cannot ignore inflationary pressures. Perhaps his mention of inflation risks will worry those for whom the answer is always easier money.


The British Government obviously decided the market was not working when it chose to nationalise Northern Rock. Private bids for the troubled mortgage bank valued its assets at a much lower level than the government’s estimate. Since the government guaranteed depositors’ money at Northern Rock, it has an interest in seeing full value for these assets. To some extent the smart money may be attempting to take quasi-collusive advantage of a rolling liquidity crisis and grab assets at fire-sale prices.

Warren Buffett appears to be trying to do this in his overtures to the bond insurers, and some players may be doing something similar in the auction rate note market. If so, governments are right to protect taxpayer interests and hold on to the assets until normal service is resumed in the financial markets. 

The crisis of the bond insurers – MBIA, Ambac and FGIC – has done nothing but worsen. They are now at the point where their capital cushion is so inadequate that they may be forced by their regulators to split. That is what Governor Eliot Spitzer of New York is demanding, and for those firms headquartered in New York he calls the shots. Their municipal bond guarantee business would go in one company and their much riskier structured investment insurance would go in a second company.

Regulators must rue the day when they ever allowed these firms to get away from their original, stodgy role as municipal underwriters.
Quite how the firms’ remaining capital will be allocated under this solution will be interesting to watch. By rights, the accumulated premiums paid by non-defaulting municipal governments and the interest thereon should go to the safe firm. That will leave little or nothing in the way of capital for the firm that inherits the guarantees of credit default swaps and collateralised debt obligations. That reality may galvanise big banks into rescuing the bond insurers, if they calculate that, it would definitely be the lesser of two evils.

Without a functioning insurance market for munis, state and local governments cannot raise cash at sensible rates. Again that could hit the real economy if they put off infrastructure work or, worse, if they have to lay off workers or raise taxes to pay higher interest expense. And if MBIA-type guarantees are worthless, holders of MBIA-backed paper have to write them down, which as the ratings agencies have repeatedly warned, could trigger another round of trouble for banks and other financial institutions. 


The good old consumer appears, if the retail numbers are accurate, to be oblivious of all this financial mayhem and its possible impact on his or her pay packet. Yet consumer confidence is way down, when measured by what people say rather than what they do at the shopping mall. It is in the nature of complex economies to give off conflicting signals. 

The fundamental problems are, nonetheless, inescapable: over-indebted households, a housing glut and unjustifiably high house prices, coupled with rampant risk-taking in many parts of the financial market. It would be amazing if the American economy did not have to pay a price for all this in the shape of a downturn this year.