Sorry it's been so long since I posted last, I actually wrote this last week, but then I lost it before I was able to post it to the blog.
Everybody in the media (except for Phil Gramm) appears to be on board at this point that the economy is in the crapper. However, most people really don't understand why. There are several big factors that are affecting the economy right now and a lack of organic demand is the one I want to talk about today.
What is organic demand? Simply put, organic demand happens when someone decides to replace a product they own or they decide to purchase said product for the first time.
Think about cars. Every year you have a whole new group of people that are ready to buy their first car (mostly teenagers and young adults). Likewise, there's also the large group of people that own cars but they need to replace it for whatever reason (cars break down, leases run out, etc.). This is a built in customer base for the auto industry and every month of every year these two groups of people provide a revenue stream for the auto makers. That is organic demand.
Now I want to go back to a dark day in our history. The terrorist attacks of September 11th, 2001. I don't know if you remember, but in the days following those attacks the economy almost completely stopped. General Motors decided to roll out a very bold advertising campaign in order to spur sales for the company.
The campaign was called "Keep America Rolling" and it appeared to be a great success. GM, for the first time, introduced 0% financing for up to 60 months on all new GM cars.
They thought they were spurring new sales, however all they actually were doing was bringing demand forward. People that were thinking about buying a new vehicle in the next 6 months decided to buy now. All GM was doing was stealing from the future.
Then the campaign ended and GMs sales fell through the floor. In order to bolster their sales they had to bring back the 0% financing and then start adding cash back incentives to spur sales. More people came in and bought cars, but again all they were doing was stealing from future sales.
The next step for GM was to start lowering their credit standards. Now marginal buyers, people who were "upside down" (meaning they owed more than their trade in was worth), or people that needed to finance a car for 6 or 7 years in order to afford the payment bought cars. In many cases people were getting greater than 100% financing to drive away in a new car.
Eventually what happens it that you hit a wall. You've pushed forward demand as far as you can go. Your pool of potential buyers has shrunk down to almost nothing because everybody that needed or wanted to buy your product for the next few years already did.
Then you throw in $4/gallon gas and you are ready for a catastrophie. GM sales are down 25% as compared to last year (and last year wasn't that great, either). There is no market for the big SUVs and trucks (GM's bread and butter) because of gas prices.
And it's not just GM. Ford, Nissan, Hyundai, even Toyota are getting hit hard with plunging sales. In June, only Honda was able to eek out a 1% gain in sales, and that's because they specialize in smaller vehicles. Every other manufacturer saw sales crash 20% or more. Only small, fuel efficient cars are selling well right now.
What can be done about this? Right now, nothing. You have to naturally allow that organic demand to form again. With high gas prices and a slowing economy, people are holding onto their cars longer. You have to let that demand build back up. Sadly, this could take several years and I'm not sure GM and Ford can wait that long for the economy to turn around.
It is the exact same problem for housing. Basically, everybody that wanted to buy a house did over the past 4 years. It didn't matter whether or not you could afford the house, or had a down payment, or even a job. The organic demand for housing is almost non-existant right now.
On top of that, you have a massive housing glut from all the overbuilding of the past few years (and they're still adding about 1 million housing units a year to our housing stock!). Right now the only real demand for housing is from people like me who are waiting for prices to come back down to a reasonable level. It will be years (maybe 2012 at the earliest) before organic demand comes back into the real estate market.
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