This Economy: Consumers 'deleverage,' and what comes next?

The new year, and the new decade have arrived. Is the "new normal" here to stay?

In case you haven't heard, the "new normal" is the supposedly new economic reality caused by the global financial crisis and the worst economic slump in 70 years. The notion is that profligate Americans have been permanently shocked into frugality.

If this is true, the implications for the U.S. economy are huge.

For 25 years, U.S. consumer spending grew at a rate of 0.5 percent faster than income, said Ethan S. Harris, North American economist at Bank of America Merrill Lynch, while discussing the "new normal" opportunities. That excess spending, powered largely by mounting debt, provided a tailwind to economic growth. "Now there could be a headwind," Harris said during a 2010 outlook conference.

Harris and other economists make a compelling case that consumers are on the straight and narrow, no longer willing to supercharge economic growth by going into debt. They cite, for example, the 3.8 percent decline in consumer credit since its peak in July 2008, the biggest decline since World War II, when credit cards did not exist.

What those numbers do not disclose, however, is how much of the decline has been caused by rejections of credit card applications. Plus, economists skip over the fact that consumer credit fell 2 percent in the short and mild recession of the early 1990s.

Perhaps economists are right, but there is a chance that the "new normal" concept stems from the same sort of thinking that produced the "new economy" hype during the dot.com bubble and the belief that it was fine to give home buyers 100 percent financing with no income verification during the housing boom.

The drive behind such thinking has always been that whatever is happening now will keep happening in the future, be it a powerful cycle of productivity gains through new technology or a period when housing prices know only one direction: up.

Hyman P. Minsky, an economist who died in 1996 but has come into vogue recently for his descriptions of capitalist economies as inherently unstable, showed how even the most insightful thinkers can be heavily influenced by recent events.

In his 1986 book, Stabilizing an Unstable Economy, written at a time when the 1970s' raging inflation was a fresh memory, Minsky tried to explain why numerous financial crises since the mid-1960s had not resulted in a repeat of the 1930s.

Minsky wrote: "What happened is that the shape of the business cycle has been changed; inflation has replaced the deep and wide troughs of depression." Just as Minsky made that statement, the United States entered a 20-year period known as the great moderation, with relatively steady economic growth and mostly tame inflation.

Time will tell if economists are right to say that the current retrenchment by Americans - millions of whom have lost their jobs while millions more worry about when they might be on the unemployment line - will continue for the foreseeable future.

It is worth noting, however, that Americans tend to feel better about the economy - and spend more - when the job market improves and housing prices are going up. There's little doubt that the job market will recover.

Less certain is the fate of the housing market. If housing prices return to the relatively slow growth rate that prevailed in most of the 20th century, consumers could remain subdued. The Obama administration is doing all it can to prevent that, most recently lifting the limits on support for government-controlled mortgage-finance companies Fannie Mae and Freddie Mac.

Hank Smith, chief investment officer for equities at Haverford Trust Co., of Radnor, is a "new normal" skeptic. "Don't underestimate the consumer," he said.

"Historically, it's been the wrong bet. Yes, we understand there's deleveraging going on with the consumer," he said. But Smith does not expect that to go on forever. "We affectionately say that consumers have some genetic chip inside them that says, 'Spend.' "