Season’s Beatings

“Black Friday” Woes

As has become customary, US shoppers have been engaged in lively skirmishes in shopping malls across the country last week, fighting it out over assorted deeply discounted “must have” gadgetry.

Here is a video showing a selection of 2015 Black Friday brawls (even small kids are getting robbed of their merchandise):

A selection of 2015 Black Friday brawls

However, it seems that in spite of the enthusiasm on display in the video, the hearts of shoppers were not really in it this year. As reported in the press, Black Friday sales fell by a rather noticeable 10%.

The headline that “sales fell as Americans opted to buy more online” is in a way a bit misleading. It seems to suggest that online sales actually made up for the decline in brick and mortar sales. This was not the case as the following chart by Zerohedge reveals:

Rising online sales were unable to offset the decline in brick-and-mortar store sales.

Let us briefly consider what this means. When the oil price collapsed in late 2014, the general view was that lower gas prices would lead to a sharp increase in consumer spending. It is clear by now that this hasn’t happened. Apparently consumers continue to suffer from the debt hangover left in the wake of massive overconsumption during the preceding boom periods as well as the housing bubble and bust. Incomes are weak, and fixing damaged balance sheets still takes precedence over increasing debt-funded consumption.

As Mish noted in a recent comment on Black Friday, only car sales are still going strong – this is however largely a function of a sub-prime financing boom egged on by ultra-low interest rates. How this boom in sub-prime lending in this sector will end should be clear (it won’t end well).

Retailers definitely cannot be happy about the recent trend:

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Trends in retailer’s sales over the past 15 years

In line with both the downtrend in retail sales and the weakness in manufacturing, now finally confirmed by ISM falling into negative territory with a reading of 48.6 (the 50 level demarcates expansion vs. contraction) – below even the most pessimistic forecast and way below consensus expectations (big surprise…) – the annualized rate of change in the Cass Freight Index of shipments has been contracting. The most recent reading for October represents a new low for the move:

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Y-o-y change rate in Cass Freight index of shipments

Boom and Bust

If we think about crude oil, this is a sector that has evidently become a classical victim of price distortions due to loose monetary policy (in both the US and China in this case). Economic calculation was falsified as a result of extremely low interest rates and monetary pumping, with prices reflecting expectations of future demand that have failed to materialize. In the meantime, money supply growth in both the US and China has faltered. A slight tightening in monetary conditions was all it took to trigger a price collapse, thereby unmasking the boom as false.

It appears as though a similar miscalculation may have been made with respect to consumer demand more generally. As always happens during booms engendered by an expansion of money and credit, the production of capital goods has increased sharply relative to consumer goods production. Low interest rates normally suggest that savings are rising, i.e., that consumers are postponing consumption in the present in favor of saving and investment, so as to be able to consume more in the future.

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Booms and busts illustrated by the ratio of capital vs. consumer goods production

However, if interest rates are manipulated by a central bank and suppressed below their natural level, then this signal is a false one. In reality, the real savings needed to support increased investment in production stages far from the consumption stage are lacking. As the boom progresses, too many consumer goods will be tied up in long-range production processes, while not enough will be released.

Eventually this inherently unstable situation comes to a head, usually indicated by the fact that upward pressure on market interest rates emerges, which will in due time stand the previous price distortions on their head (the increase in capital goods prices relative to consumer goods prices will begin to reverse). As you can see below, upward pressure on market rates is indeed emerging, especially at the short end of the yield curve:

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2 year note yield, weekly

Once the reversal in the price structure can no longer be denied, a bust will be at hand. The distorted production structure is then found to produce too many goods that are actually not in demand, and too few of those that are. A complete rearrangement of the capital structure will become necessary at that point, which inevitably includes the liquidation of malinvested capital that is too specific to be profitably transformed, along with the liquidation of unsound debt associated with such malinvested capital.

Some partially finished investment projects will have to be abandoned, due to a lack of resources to actually finish them. However, at first there will be a scramble for scarce funds, as some entrepreneurs will desperately attempt to finish such projects to avoid a complete write-off. At the same time, demand for additional capital will still emerge in industries in lines that are tied to already finished early stage investments which wouldn’t have been undertaken had the real situation been known, but which after writing off sunk costs can still be operated at break-even or a slight profit. Thus competition for scarce capital (scarcer than originally thought) will heat up ahead of a bust, intensifying the pressure on market rates further and hastening the bust’s arrival.

The economy may actually be quite close to the tipping point, as evidence of its weakening continues to emerge. The evidence in its entirety is not yet indicating a recession, but merely a sharp slowdown. Every recession is preceded by a sharp slowdown, but not every sharp slowdown turns into a recession. Much will depend on future trends in monetary conditions and the degree to which the economy’s pool of real funding has been exhausted.

Conclusion

The post-GFC economic recovery seems to hang on an ever thinner thread. As we have stressed previously, it is no consolation that the manufacturing sector is currently affected most heavily, while many service industries are still doing well (although less well than before, if the Chicago PMI is any indication). Including intermediate production stages, manufacturing’s contribution to total gross output is far higher than GDP indicates, and it is ultimately the foundation on which the economy rests. The weakening growth in retail sales is additional confirmation that all is no longer well.

Charts by: zerohedge, St. Louis Federal Reserve Research, StockCharts