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The last week was witness to rise in global stock markets coupled with a dip in the dollar and the Yen. This seemed to indicate that risk appetite was returning on the back of the rescue packages being put forth by governments all over the world. This was also coupled by the Monetary Policy measure of reduction of interest rates by the US Fed amongst others. Lower interest rates could provide a trigger for economic stimulus. However, consumption expenditure still seems to be a key problem area? That still seems to be shrinking for the largest consumer in the world, the US. So who is going to buy all the goodies from Japan and China and rev up the global economy? How far can investors pull up demand in the real economy? And if the investors’ economy is leveraged upon the real economy, then the return of the risk appetite may just be a flint in the dark.

Latest data released on October 30, suggests that the US economy shrank at an annualized rate of 0.3% in the third quarter. Consumer spending, which accounts for nearly two thirds of the US GDP, shrank by an astounding 3.1% annualized rate. This is being touted as the first contraction since 1991 and the biggest drop since 1980. It appears that this contraction has not bottomed out as yet as unemployment rate zoomed to 6.1%, with major large US corporations announcing job cuts. If unemployment is on the rise, consumption is likely to shrink further.

The previous consumer boom, it appears, was largely based on home ATMs, or borrowing against ever rising home prices providing unlimited money to consumers to continue their spending spree. We all know that the US housing boom was a bubble waiting to burst. Now, with that important source of money gone for Americans and with unemployment on the rise, one can only assume a very slow recovery for consumption expenditure. And that casts a dark shadow on prospects for a quick global economic recovery. To worsen matters, home prices in the US still do not seem to have found their floor. The S&P/Case-Shiller index for house prices for ten cities fell a whopping 17.7% year on year till September 2008. Psychologically speaking, American can’t get over the ‘sinking feeling’. 

So what does the government need to do to stimulate consumer spending? Mere lowering of interest rates is unlikely to spur investment and spending that may have happened during a boom period. Banks are in the ‘once bitten twice shy’ mode. They will be reluctant to lend freely and are likely to be very stringent and lend only to the most credit worthy. With Americans having such high credit default rates due to the housing bust, its anybody’s guess as to which way lending will go.

What the government probably needs to do is to kick start the economy by providing a fiscal stimulus to spur consumer spending. Increase in consumer spending will encourage an increase in production and loan off take by industry could also get galvanized. This could set up a virtuous cycle and help bring the economy back on track. The fiscal stimulus could come in the shape of tax breaks like the ones offered earlier this year.