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Where is the pent-up demand!

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					                    Where is the pent-up demand?!?

Saxo Bank Research Note        September 2, 2009.       Chief Economist David Karsboel


Please tell me!
Yes, we respect the momentum in stocks. Yes, we can see the stimulus – both monetary and fiscal.
Yes, there might be “cash on the sidelines”. Yes, frightened fund managers might be chasing their
benchmarks. Yes, the recession has been long and deep. Yes, housing has become so much
cheaper. Yes, earnings have already dropped a third. Yes, we can!

But please tell me where the pent-up demand is? Show me how the roasted demand-pigeons will fly
into the mouths of the priced-for-perfection equities. The rally in equities seems to imply that
Western consumers have set aside thousands of dollars and Euros in every one of the bubble years.
But if that is the case, why are they continuing to default on their debt obligations? Indeed, why
are they spending less and less and paying off more and more of their debt? Why are “cure rates”
(i.e. the share of delinquent mortgages that begin generating cash again) on even prime mortgages
collapsing? According to the Fed, 6.49% of all US bank loans and leases are now delinquent - the
most since 1985, when data began.


           Delinqencency, % of All Mortgages        Under Foreclosure, % of All Mortgages
  10
   9
   8
   7
   6
   5
   4
   3
   2
   1
   0
       01-03-1979
       01-12-1979
       01-09-1980
       01-06-1981
       01-03-1982
       01-12-1982
       01-09-1983
       01-06-1984
       01-03-1985
       01-12-1985
       01-09-1986
       01-06-1987
       01-03-1988
       01-12-1988
       01-09-1989
       01-06-1990
       01-03-1991
       01-12-1991
       01-09-1992
       01-06-1993
       01-03-1994
       01-12-1994
       01-09-1995
       01-06-1996
       01-03-1997
       01-12-1997
       01-09-1998
       01-06-1999
       01-03-2000
       01-12-2000
       01-09-2001
       01-06-2002
       01-03-2003
       01-12-2003
       01-09-2004
       01-06-2005
       01-03-2006
       01-12-2006
       01-09-2007
       01-06-2008
       01-03-2009




Source: Bloomberg

To me, it looks like the consumers have finally hit the wall where there is essentially no pent-up
demand left. After decades of systematic and constant demand stimulation via artificially low
interest rates and the emergence of the “demand-driven economy” (as if there ever was any such
thing!), we have succeeded in borrowing so much from future demand that our present GDP has
been overstated by 10-30%. How many resources have been put to use in order to make American
consumers push their excessive debt-financed consumption to new highs? How many malls,
shopping centers, financial intermediaries, debt extension companies and SUV dealers have been
set up for which there is no long-term use? And by how much has that overstated prior GDP figures,
since these types of companies were mal-investments and need to be written off?

Pent-Up Demand
There is no fixed definition of pent-up demand – the demand that Keynesians assume will be
released if rates are cut enough – but if we assume that it consists of the last two years of savings
and the home equity, the following picture emerges:




Source: Bloomberg + Saxo Bank Research

Note, how much pent-up demand policy-makers could unleash in 1982 by cutting rates or taxes.
The total pool was more than 250% of GDP. Today, as a result of persistently low savings rates and
massive home equity extraction, the total pool of pent-up demand is below 100% of GDP – and only
rising due to a higher savings rate in recent quarters. In other words, the pent-up demand by this
definition has never been lower since 1960.

This is why the Keynesian central bankers can’t sleep at night: Their eternal demand-stimulation
does not work any longer. The pent-up demand is non-existent (by historical standards) and
therefore cannot be released, even if rates are aggressively cut. Total bank lending has dropped
almost 6% from the top in late October 2008. That has never happened before. The picture is the
same in the Eurozone and (of course) in Japan:
                                 US Banks: Commercial and Industrial Loans and Leases YoY
  10

   8

   6

   4

   2

   0

  -2

  -4

  -6
       31-01-1973

                    31-01-1975

                                  31-01-1977

                                               31-01-1979

                                                            31-01-1981

                                                                         31-01-1983

                                                                                      31-01-1985

                                                                                                   31-01-1987

                                                                                                                31-01-1989

                                                                                                                             31-01-1991

                                                                                                                                          31-01-1993

                                                                                                                                                       31-01-1995

                                                                                                                                                                    31-01-1997

                                                                                                                                                                                 31-01-1999

                                                                                                                                                                                              31-01-2001

                                                                                                                                                                                                           31-01-2003

                                                                                                                                                                                                                        31-01-2005

                                                                                                                                                                                                                                     31-01-2007

                                                                                                                                                                                                                                                  31-01-2009
Bank credit is being reduced because de facto insolvency is widespread in the financial system and
because there is no effective demand for new credit. As long as consumers are frightened of being
laid off, the savings rate will stay high and probably approach the level of the 60s and 70s. Too
many consumers have become painfully aware of how much they have depended on credit lines
from the bank system and how much that means in today’s world.


Demand is going to disappoint
The Keynesians never get tired of telling us that 70% of GDP is consumption. This is obviously a
misleading statement – as if we can consume ourselves rich. If we want growth in the Western
economies, this percentage has to come down and investment and savings should be higher. This is
the only long-term solution to the extreme difficulties that we are confronted with. Only by
growing our capital base will we be able to increase production and growth. It is time we learn
from the Chinese or simply look in the history books and be inspired from how the economy of our
ancestors could grow even though they didn’t consume 70% of their income immediately.
The future economy of the Western countries will be investment-driven – if driven at all.
Unfortunately, it also means that the companies that are most dependent on consumption will be
underperforming in the years to come. Demand is permanently impaired and will not come back to
2007 levels soon.
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