EC HH Consumer & Business Leverage & Risks For Economy

When the economy is near the end of the business cycle there tends to be excess leverage taken out by businesses and consumers. The recession washes away the bad loans to get back to equilibrium. It was important for the housing market to cool off after the run in the 2000s because housing became unaffordable. The size of the bubble and the terrible lending standards were the problem, not the recession. There is a notion that just because the current expansion is about to be the longest in over 100 years the economy needs another recession. In fact, the economy doesn’t need another recession because consumers and corporations haven’t taken out excess leverage.

Extreme Recency Bias

There is negative recency bias because the last recession was a disaster and because this expansion has been very long by America’s historical standards. The longer it goes, the stronger the bias gets because people think we are a due for a huge crash. There are obviously solid bearish arguments why stocks should fall and the economy should go into a recession soon, once we have evaluated in the past considerably. However, claiming personal and corporate leverage are too high is not a good argument.

Consumers Saving Too Much?

Most mainstream articles in finance lament how terrible Americans’ finances are. There are a plethora of articles showing Americans how to save. It’s heresy to say the American consumer is saving too much. The Renaissance Macro Research chart below shows the consumer is saving more than usual after the latest update to this calculation was made. The chart shows when there is a high net worth to income ratio, consumers usually save less money.

(Click on image to enlarge)

Source: Renaissance Macro Research

The theory is that when housing prices and stock prices are increasing, consumers are optimistic about their gains. They feel richer and spend more money. The reality is you shouldn’t expect the good times to continue indefinitely. Asset prices can go down, making it a mistake to shrink your savings. It may end up being a bad idea to buy assets when prices are high, but no one says you need to buy assets with your savings at that point. You can build up a cash position in your portfolio to buy during the next correction when prices of assets fall. This, however, requires lots of patience and discipline. 

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Gary Anderson 6 days ago Contributor's comment

So how much leverage is derived from high flying tech stocks? What happens if China causes Apple stock value to crumble?