2009Mar Decremental Economy

The Wall Street Journal * writes, “Every era on Wall Street has its buzzwords, terms that capture a prevailing mood or business theme. In today's era of economic decline, that term is ‘decremental.’”

 

Decremental?  Well, there you have it. 

 

Decremental is the opposite of incremental, and it describes growth in reverse.  Incremental profit is that extra slice of profit you get for each additional dollar of revenue, the “marginal benefit” in economist-speak.  Decremental loss is that marginal loss for every extra dollar of lost revenue. 

 

Welcome to the world of excess capacity and deflation. If this seems hard to comprehend, it is because it is a foreign concept to most people.  Everyone alive today, even those who lived through the Great Depression, have spent virtually their entire lives in an expansionary and inflationary boom.  Shrinking demand and falling prices have simply not been a fact of a life for decades.

 

When the economy is shrinking, prices shrink too, though the costs of inputs have often already been incurred as sunk costs.  This means that economies of scale, which boost profitability during the boom times, are often transformed into diseconomies of scale during contractions.

 

These kinds of conditions create shake-outs, in which the strongest companies survive and the weaker ones fail.  In this process of creative destruction, the survivors can either buyout their weaker competitors or they can simply expand to fill the vacuum once the economy recovers.  This is what happened during the Great Depression.

 

Of course, these supply-side arguments do not answer the burning question on everyone’s mind:  when will demand recover?  To this question, we have an answer that should offer at least some level of encouragement.  The American birthrate is currently soaring at levels not seen since the late 1950s, during the height of the original baby boom.  The Baby Boomers are now becoming grandparents, and this is an unquestionably bullish signal for the future!

 

Children can be thought of as inflationary demand sponges; they produce absolutely nothing and consume everything in sight.  They also get progressively more expensive the older they get until they finally leave the house at around age 18.  The children being born today will not have much of an impact this year, but as their numbers increase and they get older, our growth cycle begins anew, as the children of the Boomers, those born 1976-1990, find themselves entering parenthood and on a fast track to increased spending.

 

We do not see this current economic crisis being “fixed” any time soon. Government stimulus is no more likely to work here than it did in Japan during the 1990s.  That said, we firmly believe that the Echo Boomers, with their current crop of newborn children in tow, will eventually spend us out of this recession.