China Is the New King

Stephanie Pomboy is an economic forecaster who took her own medicine. A few years ago, after she’d been warning clients (and friends) that the housing boom was not sustainable, she sold her Gramercy Park apartment and rented a place in Chelsea. Now that the market has tanked, she is not yet thinking about diving back in. In the weekly newsletter she produces for her firm Macro Mavens, Pomby remains very cautious, even a bit fearful, about the economy.

How does the city seem to you these days?
When I look at the statistics, I would think that you could hear a pin drop in the average New York restaurant. Yet my experience has been that they all seem pretty full. But that’s a fairly limited sample and there are plenty of indicators pointing the other way. Traffic isn’t as absolutely horrendous as usual. And the taxi-driver indicator is certainly about as glum as it ever gets.

What about the shops?
It’s amazing the amount of salesperson contact I’ve had in the last few weeks. It’s a sign of how desperate they are for business when they’re actually reaching out to me to say, “Hey, you haven’t been in the store for a while. We’ve got some great spring stuff.”

Have you embraced the new frugality?
This is where I have to put the economist hat on, because it’s too early to tell if what we’re seeing in terms of the decrease in consumer spending and rise in the saving rate is a temporary or long-term phenomenon. My hunch is it’s the latter.

And I just think back to the dot-com-bubble bust in 2000. If you look at what the corporate sector did after that bubble burst, you see for the better part of five years that they hunkered down, and they hoarded cash and they reduced debt, and they did no capex. That was what got them into trouble. They went way overboard on capex, and so they cut it out completely.

Capital expenditures. Basically, they were busy trying to repair their balance sheets rather than looking for ways to grow. So they didn’t increase expenditures on plant or equipment, or hiring people. So that’s why you had this subpar employment recovery following the 2000 recession.

So you think consumers are going to behave like the corporate sector did?
Yes, I do. It took companies the better part of five years to really get around to feeling okay. And that was in an environment in which consumers were cashing out $40,000 in home equity and spending like drunken sailors. So if that level of end demand couldn’t lure the corporate sector to be more aggressive and expand and hire, it¹s really a testament to how deep those emotional scars were. I think it will be the same with consumers.

So when does the recovery begin?
My feeling is that the economy can stop declining in relatively short order.We’ve seen this huge reduction in consumer spending. Households paid down debt for the first time in the history of the Federal Reserve tracking that data, which goes back to 1956. This response was like when you touch a stove and get burned, you yank your hand away. The pain subsides, but that doesn’t mean you’re going to reach out and touch the stove again.

That doesn’t sound too awful.
The risk is that the longer consumers try to repair their balance sheets, the weaker the outlook for corporate profits. If they’re not going to spend as much, top-line revenues for companies slow, and that really reduces their impulse to hire people. In fact, it intensifies their urge to lay people off. So you run the risk of getting into this negative feedback loop where consumers are trying to save, and therefore companies are laying them off, and therefore they have no money to spend, and around and around you go.

Do you think the whole economy has to be restructured? Less finance and retail, more manufacturing?
At the end of the day, the choice really isn’t ours. It’s China’s, and the rest of the global creditors’, as to whether we’re going to be able to borrow our way out of this fix, which is obviously what Washington’s trying to do.

But over time, I would not be at all surprised to see manufacturing become a gross sector in the U.S. economy again.

What kind of advice are you giving your clients about how to make money in this climate?
My feeling is, you need to start figuring out which companies are going to exist five years from now. Because we don’t need 27 companies that essentially sell T-shirts. So you need to figure out which are the fittest that are going to survive in the consumer space. That would be one thing.

And the other is, if I’m correct on this long-term restructuring of household balance sheets, what are the implications in terms of international markets? Does the rest of the world try to cling desperately to this freeing raft of U.S. consumers by competitively debasing their currencies to keep their chief exports flowing our way? Or do they have the epiphany that, hey, this isn’t going to be a long-term play for us anymore?

What about the banks—are they going to be okay?
I would certainly not be a buyer of financial stocks. I worry about what’s going to happen as we move down the chain from the big money-center banks and brokerage firms down to smaller banks, regional banks, where the mortgage loans are all sitting on their books. They weren’t part of the whole securitization mania where they took all these mortgages and securitized them and got them off their books, and then foolishly repurchased the same securities. They actually made the loans and retained them. So that’s all rotting in the regional bank area, and it’s starting to come to light.

See Also
A Worrier’s Guide to Our Economic Future

More Interviews
Niels Jensen on Europe’s Economic Outlook
James Grant on Finding Promising Opportunities
Amar Bhide on How the World Will Adjust

China Is the New King