"The Consumer"

Investors who spend much time reading financial predictions or watching the financial media can't help but hear about the powerful entity known as "The Consumer."

This amazing being figures so prominently in conventional economic analysis because many analysts attribute superhuman powers to The Consumer. In their view, The Consumer moves the entire economy, or if not the entire economy, The Consumer moves so much of the economy that there isn't much value in focusing on anything else.

When the economy is moving ahead, in the eyes of these pundits, it is because The Consumer is lifting it. Normally, The Consumer is full of something called "Animal Spirits," causing the economy to grow almost singlehandedly (of course, even the believers do not allege that The Consumer does it all singlehandedly, but they say that 70% or even 80% of the work is done by The Consumer, which is almost the same thing*).

Sometimes, however, The Consumer becomes weakened. The cause of this weakness is never precisely explained (possibly kryptonite), but it appears that The Consumer is prone to bouts of depression, or at least self-doubt, during which the economy either stops growing and stagnates for a time, or even slips backwards into recession.

You can hear or read the opinions of those who believe in the mighty role of The Consumer literally every day in the financial media. One recent example is found in the video clip below from CNBC, in which Harvard professor Niall Ferguson invokes The Consumer:

In the above exchange, particularly the segment beginning around 05:40 into the clip, Larry Kudlow -- concerned that the Fed is keeping rates too low, as we have opined previously -- asks Professor Ferguson, "Will the Fed drain cash, will the Fed raise rates, will the Fed move to an exit strategy? And, I guess -- heaven forbid, Niall -- will we ever stop this explosive borrowing coming out of Washington?"

To this flurry of questions, Professor Ferguson replies, "Well, I don't see any end in sight to the explosive borrowing. We're on a $9 trillion cumulative deficit over a ten-year timeframe and right now I think it's way to early to talk about exit strategy for the Fed. I don't buy the idea that this is a V-shape or even a 'W' -- I think it could be a flatline, given the condition of The US Consumer. So, I don't really see any reason why the combined forces at work here, a huge deficit plus easy money, are going to go away any time soon."

Later, Professor Ferguson adds, "I think they're too scared that this economy could go dipping downwards again and I think they've good reason to be. They also know there's no inflation risk -- you know, they could let the dollar go down another 30% or more."

The problem with this belief in the crucial role of The Consumer is that it is simply false. It is -- as we have playfully suggested in the above paragraphs and images -- a myth, a fable, a comic-book view of reality.

In fact, it inverts reality altogether. As George Reisman, Professor Emeritus of Economics of Pepperdine University, wrote in Capitalism: A Treatise on Economics, this inverted view of the world can be called "consumptionism," which he defines as "the doctrine that the fundamental problem of economic life is how to increase the need and desire to consume in the face of an ability to produce that exceeds them" (543).

In other words, the proponents of this inverted view of reality believe that man's need and desire to consume is fixed and constant, just like the other animals (presumably, dogs and horses do not sit around wishing they had big-screen televisions -- they are satisfied with having their basic needs met). However, because man is able to produce so much more than we need, we are always in danger of having an "output gap" of products and services that exceed the desires of The Consumer, whose desire to consume must then be stimulated somehow.

In this ludicrous view of the world, an endless supply of big-screen televisions can be taken for granted from the production lines of the world -- the real problem is somehow stimulating the lethargic consumer to actually desire a newer and better television than the one he has.

The reason this is an upside-down view of the world is that man, unlike animals, can and does always desire something better. If he secures a newer and larger television, it will not be long before he wants one with even higher definition, or with the ability to connect to his stereo wirelessly, or with the ability to connect to content that is delivered over the internet, in 3-D.

If the above television example does not work for your own particular consumption patterns, you can no doubt think of items for which the above pattern would hold true, whether it be food, housing, cars, surfboards, clothes, travels, or power tools. In short, the desire to consume does not need to be stimulated at all -- it can essentially be taken for granted!

However, the ability to produce goods and services is not automatic. The consumptionist mentality just assumes that goods and services will continue to be produced, often in excess of The Consumer's desire to consume them, regardless of how many obstacles to production are erected in the form of taxes on business returns or regulation of free trade or confiscatory government corruption. Unlike the desire to consume, the desire to produce can be completely squashed by foolish policy. For instance, if you lived in a country where the police did not stop looters from breaking into your store and taking all your goods, you would soon learn not to build a fixed store with inventories of goods and services. This is why in most countries without the rule of law, small-scale stands in open-air markets and bazaars are the norm, rather than larger permanent shops which can take advantage of economies of scale. Generally speaking, in those countries, scarcity is the norm, and sufficient quantities of goods and services to meet the basic needs of all those who desire them are not produced.

For this reason, Professor Reisman says that the consumptionist worldview is completely upside-down. "Instead of taking the need and desire to consume for granted and focusing on the ways and means by which production might be increased, the problem of economic life is now believed to be how to expand the need and desire to consume so that consumption can be made adequate to production" (544).

The problems with the widespread belief in the superhuman role of The Consumer are many. First, predictions about the future of the economy that are based on trying to take the pulse of The Consumer are usually inaccurate. Investors should be very attentive when they hear a talking head on the financial news shows begin to invoke The Consumer, because what follows will likely be driven by the mistaken belief that The Consumer moves 70% of the economy. The widespread nature of such mistaken views, however, has no doubt been responsible for much fear and doubt among the general populace in the past, and will continue to be in the future.

Another negative impact from this consumptionist view is the role it plays in misguided policy, from excessive monetary stimulus at the Federal Reserve to excessive spending out of Washington in its attempts to "stimulate" The Consumer.

The United States often elects consumptionist leaders who believe in the outsized power of The Consumer and miss the importance of the portion of the economy that is responsible for economic activity along the stages of production, and therefore craft policy that penalizes everything else in the interest of The Consumer. We have written previously about ways investors can gauge the degree to which production is being hindered in an economy by these policies, and how investors should adjust when this takes place.

This is a vital concept for everyone to understand -- please share this knowledge with your friends and family.

* The root of the widespread belief that The Consumer is responsible for 70% or 80% of economic activity lies in the way the so-called "Gross Domestic Product" or GDP of any nation is measured: because of the way it is constructed, the GDP formula purposely excludes intermediate goods used in the production of end products, thus artificially increasing the percentage of economic activity attributable to consumer goods. Additionally, GDP is simply one measure of economic activity; there are many more, such as Industrial Production, that give insight into the productive side of the economy.

Subscribe to receive new posts from the Taylor Frigon Advisor via email -- click here.