Posted on March 26, 2009 - by Venik

Round Two

CNBC’s Jim Cramer believes that the economic recession might have reached the bottom and that we already are beginning to see signs of improvement. Indeed, the slightly-lower-than-expected quarterly decline reported by Best Buy infused financial analysts with much optimism. But even superficial analysis of Best Buy’s performance during the past quarter reveals the true reason for this small boost in sales and its nothing we should be getting too excited about.

Circuit City filed for bankruptcy in early November of last year. While the stores remained opened until mid-January, Circuit City has largely missed out on the holiday shopping season due to buyer concerns about service plans, return policy, and redeemability of Circuit City’s gift cards, among other issues. Best Buy picked up most of Circuit City’s business, but even so, its sales were considerably lower than during the same time last year.

It is quite a stretch to say that Best Buy’s recent performance is in any way an indication of the beginning of economic recovery. Meanwhile, thousands of miles from Best Buy’s headquarters in Minnesota, Russia’s finance minister Alex Kudrin is making some uncharacteristically gloomy predictions about the global economy. In a nutshell, he believes that the hike in the unemployment rates around the world drives up the percentage of defaults and will lead to a second wave in the banking industry crisis.

Kudrin is a known party pooper – being Russia’s finance minister he has no choice but to be a pessimist – but this doesn’t necessarily mean that he is wrong. Even though he is talking primarily about the Russian economy, the same logic would seem to apply to the US economy and on a much grander scale. In the past several months the US economy lost millions of jobs. The effects of rising unemployment take some time to materialize. A few months is needed for the newly-unemployed to eat through their savings, unemployment benefits, and credit before they start defaulting on their loans.

The US lost 2.6 million jobs in 2008 – an average of about 217,000 jobs lost every month. In January of 2009 the US economy shed 598,000 jobs and in February – another 651,000 jobs, taking unemployment from 7.6% to 8.1% in just four weeks.

“These jobs aren’t coming back,” said John E. Silvia, chief economist at Wachovia in Charlotte, N.C. “A lot of production either isn’t going to happen at all, or it’s going to happen somewhere other than the United States. There are going to be fewer stores, fewer factories, fewer financial services operations. Firms are making strategic decisions that they don’t want to be in their businesses.”

(source: Job Losses Hint at Vast Remaking of Economy, by P. Goodman and J. Healy, NYT, March 6, 2009.)

The average American makes about $40,000/year before taxes (about $32,000 after state, federal and other withholdings). Unemployment benefits typically pay around 50% of previous income and they last for about six months. The average American carries about $5,000 in credit card debt and the average household has about $35,000 in debt (not counting mortgage). The average household liquid savings (what you and your spouse have in your bank account – either checking or savings – available for immediate use) is only about $2,500. On the average, Americans save only about 40 cents for every $100 of take-home pay. Thus, if your take-home pay is $32,000, your yearly liquid savings are not worth my time to use a calculator.

Households with credit cards (about 75% of all households) on the average have six credit cards with $3,500 of credit line on each. The average revolving credit card balance is $8,000 per household (a minimum monthly payment of about $320), leaving about $13,000 of unused credit, of which about $3,600 is available for cash advances. Using credit cards as a safety net in case you lose your job is an extremely short-term solution. The average American will not be able to sustain his regular expenses for more than 3 months after losing his job.

People delay defaulting on their credit card loans for as long as possible, because credit card companies quickly respond to late payments by severely reducing credit lines. Recently, large credit card companies increased the minimum payment from 2% to 4% on the balance owned. This is a response to rising unemployment and people trying to max out their credit cards before almost inevitably defaulting. The time is rapidly approaching when the economy should start feeling the effects of the 2.6 million jobs it lost during November-February period.

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