Posts Tagged ‘consumers’

Economy in downsizing phase

Thursday, May 29th, 2008

Recently, we noticed a trend in some housing neighbourhoods. Large four bedroom houses are sprouting out “For Sale” signs. At the same time, the “For Sale” signs for smaller and cheaper three bedroom houses disappeared much quicker than their four bedroom counterparts. What is happening?

Our theory is that as the Australian economy slows down, people are downsizing. As interest rates rise, the mortgage debt burden for the more expensive four bedroom houses increases. In order to cope, some owners decide to sell them and downgrade to cheaper three-bedroom houses, which will lighten their mortgage repayment burden. Meanwhile, less and less people are able to afford the more expensive four bedroom houses and as a result, their sales slow down. It is also possible that people more from more expensive suburbs to cheaper suburbs. That explains why these three bedroom houses sell much faster then their four bedrooms ones due to competition from ‘outsiders.’

If you look around, you will find the same for cars. People are downsizing from the more expensive petrol guzzling fast cars to smaller and petrol-conserving cars.

When it comes to retailers, the same principle holds. As the economy slows, retailers in the upmarket and more luxurious end will suffer slowdown in their sales as consumers feel less wealthy (see the negative wealth effect on The Bubble Economy), cut costs and reduce their discretionary spending. At the same time, retailers in the bargain end (e.g. the Everything-$2 shops) may experience an initial upsurge in their sales as consumers who used to spend in the upper end downsize to the cheaper end.

So, what is the lesson here for investors?

In the initial stage of an economic slowdown, stock prices of upmarket retailers will decline as their sales fall. But stock prices of the bargain retailers may see their sales rise initially. If the economic situation remains in limbo, this may be a case for selling the stocks of upmarket retailers and switching to bargain retailers.

But there is a potential trap here. What if the economy deteriorates further into a severe recession (or touch wood, depression)? Then it will be very likely that even some bargain retailers will not be spared as consumers’ spending powers evaporate through rising unemployment.

In short, during the initial downsizing phase of the economy, there will be winners and losers. But if the economy worsens further, even the winners may still lose.

What cause booms and busts? Explanation of Austrian Business Cycle Theory metaphor

Wednesday, February 7th, 2007

In our previous article, What cause booms and busts? Introduction to the Austrian Business Cycle Theory, we introduced the Austrian Business Cycle Theory (ABCT) with a metaphor. Today, we will explain the meanings of the metaphor from the book, Economics for Real People.

As we all know, since we live in a world of scarcity, the economy has a finite amount of resources (e.g. land, capital, labour, technology, raw materials, etc) to produce the goods and services that consumers want. Thus, the gas in the bus represents all the available finite resources in the economy.

The economy is always producing goods and services. Thus, the trip across the desert represents a period of time of economic activity.

In any economy, there is a class of people called the ?entrepreneur.? They are the business people who take risks by anticipating what consumers may want in the future and create the products and services that meet these anticipated needs. A very good example of an entrepreneur is Henry Ford who introduced the motor car to the world. In the metaphor, you, the bus driver, represent the entrepreneurs in the economy.

Then there is a class of people called the ?consumers.? Basically, consumers enjoy the fruits of the economy?s production of goods and services?they ?consume? resources of the economy. The passengers in the metaphor represent the consumers of the economy. As we said before in The myth of financial asset ?investments? as savings, there is a need to make a choice ?between producing consumer goods for current consumption or capital goods which will help in producing future consumer goods.? In the metaphor, the choice to use how much air-conditioning for comfort represents the choice of the consumers in how much they want to consume now at the expense of saving for future consumption.

In the economy, the entrepreneurs will borrow capital to engage in investment spending in order to fulfil what the consumers may want or need in the future. The speed of the bus represents the amount of investment spending to undertake.

Finally, the bogey man who tampered with the passengers? survey results is the central bank, which sets the interest rates. Please note that we are not accusing the central banks of any misconduct?they happened to fit the villain in our choice of metaphor.

So, how do all these fit into the explanation of the business cycle? Stay tuned!