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Why U.S. consumers are the ratings equivalent of junk bonds

A Bank of America/Merrill Lynch report says U.S. consumers are now drawing down savings to maintain their consumption.


If U.S. consumers were corporations, say the economists at Bank of America/Merrill Lynch, they'd be getting "junk" ratings from the debt-ratings agencies.

That sharply-worded view is behind the group's recent skepticism about the strength of the U.S. recovery, specifically whether the country's economy has hit a "sweet spot" of self-reinforcing cycles.

"In this narrative, job growth is spurring income, boosting spending, and the cycle repeats," the bank's economics group wrote in a recent report. "Stronger economic news, in turn, boosts asset prices, reinforcing the positive cycle of spending, income, and jobs. As a result, optimists argue, the U.S. has returned to its traditional role of leading a global cyclical recovery."

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Here's why they're doubters, expecting instead that growth will slow in the second half:

  • The good news about the drop in the unemployment rate is misleading, as the decline has been caused primarily by workers dropping out of the labour force. The ratio of employment to working-age population has shown no improvement.
  • While payroll numbers have increased, real income growth has slowed and has even fallen recently, breaking the traditional relationship between increased hiring and better incomes. As wage growth slows, gas prices cut into real incomes, while government transfer payments decline and taxes rise.
  • The recovery in the stock market has been partly offset by the decline in house prices. The recent crisis, the economists say, pushed the net-worth-to-income ratio back to 1990s levels, and remains “deeply depressed” despite the equity markets’ last three years.
  • Consumers, acutely aware of these things, are now drawing down savings to maintain their consumption. After a sharp increase in the savings rate in 2008 and continued high levels into 2011, the number has now hit a post-recovery low.

This adds up to a "poor income statement and balance sheet" for U.S. households, meaning they "haven't lost their 'junk bond' credit rating."

And it means, in the group's view, that U.S. economic data will soften as gasoline prices increase, with consumer spending underperforming. Businesses will "recognize the risks of the fiscal cliff" first and cut back on hiring; consumers will then recognize the hazards and delay discretionary spending.

"In sum," the group says, "a true virtuous cycle still seems a long way off."

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About the Author
Business and investing reporter and columnist

A business journalist since 1994, David Milstead began writing for The Globe and Mail in 2009. During eight years at the Rocky Mountain News in Denver, Colo., he individually or jointly won nine national awards from SABEW, the Society of American Business Editors and Writers. He has also worked at the Wall Street Journal. More

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