by Michael Sanibel

Created on: November 05, 2009   Last Updated: January 12, 2010

During tough economic times, you will constantly hear the question asked: have we hit bottom yet? Whether it's the stock market or housing, everyone likes to think they can jump in at the bottom and buy at historically low prices. One of the best indicators that the bottom has been reached is to stop hearing that question. This occurs when people that have been holding stocks and waiting for them to go back up so they can sell, finally give up hope and dump them. It's called capitulation, and the same can be said of homeowners that still believe they should get the same price their neighbor got three years ago. Sooner or later reality sets in and they finally throw in the towel.

Consumers are faced with the same psychological dilemma as they are forced to cut their spending as job losses continue to mount. The root of the problem is that fictional consumer demand was propelled by ever-increasing asset values. While homeowners enjoyed rapid escalation in their equity, they pulled it out as cash through refinancing and home equity loans. This fueled huge demand that convinced manufacturers and suppliers to ramp up their production and distribution of goods and services. Thousands of new stores, restaurants, and other retailers sprang up to meet the new demand. When the bubble finally popped, the economy was left with too much capacity and inventory, leading to a precipitous drop in stocks and asset values across the board. Consumers retrenched and pulled in their spending, fearing greater losses before things got better.

The economy is now resetting to a new reality and true demand. It has been a slow and agonizing process, but one that is necessary for any measure of sustained recovery. Housing construction came to a virtual standstill and inventories of consumer goods were drawn down. Companies downsized and production line output was reduced. The net effect of this will be the eventual equalization of supply and demand, which were distorted by record levels of personal debt and the granting of loans to people that couldn't afford them.

It's not uncommon for businesses in such an environment to overcompensate by cutting back more than is actually necessary. By overshooting layoffs and production cutbacks, this has the potential to create shortages for certain goods as demand normalizes and consumers start to gain confidence in a recovery. For most people, the end of recession is not apparent until they see a positive impact in their own lives. If they are still unemployed, or are having trouble paying their bills, all the favorable economic data in the world won't convince them to start spending again. Until they perceive that stability is returning to their personal environment, they will be reluctant to emerge from their shells.

There is also a psychological barrier that needs to be overcome. When businesses believe that things can't get any worse, the passing of that threshold will cause them to start thinking about hiring employees, rebuilding inventories, and implementing expansion plans. Among the incentives currently in place are historically low interest rates, enabling the revitalization of capital investment. People that have been reluctant to spend can only hold off for so long from making purchases that they delayed as the recession intensified. Consumable items that have to be replaced at some point due to wear and tear will be the first to reap the benefits of a recovery.

The danger in all of this is that the government fiscal stimulus is being entirely funded with more debt. This not sustainable and presents a substantial risk to future economic growth.

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