Global News

April 2, 2003
Debt, Demographics and Telecom

UNITED STATES -- Market analysts at Probe Research are starting to twitch in concern over how long the consumer economy can last. With the financial markets approaching the end of the third year of the bear market, and with a lot of uncertainty over what will happen -- and when -- with Iraq and North Korea, consumer confidence has fallen precipitously. According to Probe, consumers are slowing the pace of spending, even if only temporarily.

Allan Tumolillo, Probe's COO said: "Much wealth has been lost, wealth set aside for college tuition, retirement, travel, and health care. What about the flip side: the growth of debt: household, business and government?" This is pertinent for several reasons:

First, consumers have yet to abandon housing and the mortgage is the biggest component of household debt. Despite a drop in confidence, house buying is still relatively strong. The obvious issue is that the trend in house buying has been to reduce the size of the down payment in percent terms. Even with low interest rates, more income goes to mortgage debt service. Total mortgage debt is about $5.8 trillion, close to 20 percent of all debt in the US.

Second, beyond housing mortgage debt, the growth in debt of all types has been huge and current account deficits in all levels of government will push the debt load up even further. The US government deficit is rising quickly and as a matter of fiscal policy, it may or may not be a good thing. Probe's point is only that huge shortfalls at the state and local levels accompany the federal deficit, and budget cuts are not keeping up with spending. Thus, debt grows!

Third, can consumers saddled with debt continue to spend the US out of the doldrums? How much more spending can they assume before it collapses? After all, all of this debt will eventually have to be repaid -- or written off and that option would not be good news for the economy for obvious reasons -- a wave of corporate and personal bankruptcies.

Some unsettling facts
Chart one shows the ratio of gross US debt of all kinds to US GDP. As of late 2002, the ratio of debt to GDP was 2.95. GDP is $10.5 trillion (T) and gross debt stood at $31.0T, a hefty number. "Consumers, businesses, and governments must service this debt via taxation, which then falls back on consumers and businesses," suggested Tumolillo. "This is an extraordinary sum, which requires at least some estimate of how it will impact the economy and, from our more parochial point of view, the computer/IT/ telecom industries."

The run-up in the debt ratio preceded the run-up in the stock markets. The chart shows the DJIA since 1970. There were the beginnings of the bull market in the early 1980s, but the big surge and most rapid run-up in the financial markets were in the mid- to late-1990s. The pace of debt growth was highest in the 1980s and it continued to grow at slightly reduced rates in the 1990s.

According to Probe, at this point, however, there are some disturbing signs, which could just be blips, but could also be harbingers of a serious slowdown in spending. Personal bankruptcies in 3Q 2002 rose 12 percent over 3Q 2001. Barron's expects personal bankruptcies in 2002 to beat the previous record of 1.43M in 2001. Mortgage delinquencies are rising, especially in the 'marginal" buyer category, individuals over-stretched to begin with: 4.50 percent in 1999, 8.05 percent in 2002 in this category.

Due to the collapse in equity values and due to the mushrooming debt load, net wealth of Americans has dropped 22 percent since 1999. In 1999, it was 6.3 times disposable income; by 3Q of 2002, it had dropped to 4.9 times disposable income.

"Clearly, we are on the cusp of a problem," commented Tumolillo. "And now, we face twin crises from the "Axis of Evil": Iraq and North Korea. War may start soon, with or without UN support, in Iraq and we can only hope it is quick and decisive."

A longer view
The chart may be an indicator for some extraordinary forces at work in the economy. The debt to GDP ratio during WW II did not come even close to the ratio following the 1929 crash. Coming out of WW II, the generation that grew up in the Great Depression came to maturity and reached its peak earning years, and spawned the boomer generation. Many people of that era did not buy on credit, other than their house, possibly a car. All the way through the Great Society programs of the late 1960s and the Vietnam War, the debt to GDP ratio was almost flat, reflecting, in part, a whole generation's approach to consumerism.

The boomer generation entered into its prime earning years in the 1980s and a happy confluence of factors arrived together as this largest generation in US history took its place in the economy:

• The full blossoming of the consumer society and the acceptance of debt as a normal part of life by the boomers, contrary to the attitudes of their parents;
• Massive wealth accumulation into IRAs, pension funds, and other financial instruments;
• Emergence of wireless and the Internet, two technologies that took advantage of the wealth accumulation, consumerism, and a huge market demand;
• Collapse of the Soviet Union which, in retrospect, removed the dread and concern over a possible catastrophic war and reinforced optimism for the future.

"If we are on the backside of these trends," stated Tumolill, "then we face a slower-growth economy for some time to come. In some of our analyses, we have discussed the impact of the coming demographic changes in America and in other nations, as aging societies and negative growth trends take root. The UN has released its own population forecasts, and for much of Europe, the trend is ominous: aging and shrinking societies in Italy, Germany and all of Eastern Europe and Russia. Even the countries that grow, France and the UK and the Netherlands grow, but slowly, and they age as well."

Immediate impacts
Probe forsees a few immediate problems:
Deflation/Inflation?: The only major inflationary trend in the economy is the price of oil; if the Iraq war moves quickly and decisively, oil prices will decline again. In telecom, there is, thus far, no indication of price inflation, only deflationary pressures as companies cut back on spending. In a deflationary environment, capital intensive industries get hurt and companies strive to bring the balance sheet in line with the new revenue realities. For companies with massive debt incurred to fuel expansion, the only alternative may be bankruptcy. One only needs to look at Japan, where deflation has set in for four years to see what such a price regime can do to an economy. Germany may follow Japan's lead.

Consumer decisions: Where will consumers put their dollars? On PCs, mobile phones, PDAs and communicators, more software and games, digital cameras, scanners, printers, DVD players, plasma flat screen TVs (at Costco, a wholesale mega store, a plasma screen TV was on sale for only $3,300. How many of those will fly off the shelves?), Wi-Fi cards and home Wi-Fi systems, and other devices? On services like DSL, cable modem, multiple cellular lines, ISP accounts, online gaming, other subscriber-based services? Or will they shift spending toward more home improvement, toward health care, savings and paying off debt? This is extraordinarily difficult to predict, but any slowdown in consumer spending in the IT area suggests longer life cycles for PCs, a willingness to "stand pat," and an assumption that home and personal systems can last a little longer than Moore's Law.

Networks: Sitting behind this are the networks, especially the US ILECs. The FCC, in its recent UNE-P decision, has recently dealt them a blow. The telcos will not spend on new gear at any pace that will satisfy vendors or the IT industry. The telcos are looking at an onrushing wall and may very well smash into it over the next few years. A slowdown in consumer spending will affect them on the DSL side (as well as the cable operators on the cable modem side).

The next few months will see either quick resolution of the Iraqi and North Korean crises, or the onset of a much bigger crisis. According to Probe, the former augers well for renewed confidence; the latter will set back the economy -- and the IT/telecom industries -- for some time to come. The demographic, deflation and debt trends (D3) require very serious rethinking on the part of the IT/telecom industries on the very nature of the business, its value proposition to end users, and the assumptions that underlie growth projections (price, useful product lifetimes).

Contact:
Web: www.proberesearch.com