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My apologies for this late response to my earlier post on the severity of this recession. I was preparing a paper for a conference. The thesis of my paper is that the experimental data shows that a photon’s probability distribution is not a Gaussian distribution. But this blog is not the right place for it here. You can tell that my focus is in building models that can be experimentally or historically verified by real world data.

OK coming back to this recession. I really hope that the policies that are being placed into effect will turn the economy around, and for this discussion ‘but may be not’. The Dow is at 8440.36 at this minute, and has come up 2,000 from its 6,440.08 low on March 09, 2009. If this upward trend in the Dow holds, this suggests that the economy should turn around 6 to 9 months from March or September to December 2009.

But this 6-9 month lag between the market and the economy is generally true when gas pump prices are below $2.00/gallon (or equivalent).

I view the economy as tessellations of the consumers’ gross incomes, disposable incomes or discretionary incomes. Then one in theory could build a probability distribution of these incomes. Unlike loss modeling where we are looking to the behavior of the tail, in the tessellate model we would cut-off or ignore the 5% or 1% tails, and model how incomes would behave under economic stress.

For example, the gross income tessellate could be used to model tax revenues, the disposable income tessellate to model consumer housing demand and ‘capex’ expenditures, while the discretionary income tessellate would be used to model retail purchases.

Using only averages we can estimate some effects of this tessellate model.

In 2006, the estimated average annual salary of a US small business employee (they account for 50% of the US workforce) was $31,049, and Conference Board tells us that the average per capita discretionary income in 2006 was $9,148. For households with incomes of $50,000 or less, i.e. small business employees, the 2006 discretionary income was $1,900 for the whole family of 2.7 people. This tells us that it is vital to know how to partition the data correctly to get good results.

The average American drives about 12,000 miles per year. At approximately 20 miles to the gallon, this translates to an annualized $1,050 when gas prices were $1.75/gallon in 1Q 2005, and $2,460 in 2Q 2008 when gas prices peaked at $4.25/gallon. (Source: American Petroleum Institute).

Or gasoline cost was up from 11.5% (2005) of discretionary income to 26.9% ( 2008 ) (using 2006 discretionary data for all years).  A sizeable increase. 

But this does not tell the whole story. From a small business employee perspective (50% of US workforce), gasoline costs went from 55% (early 2005) to 90% (mid 2006) to 130% (mid 2008). Definitely not sustainable.

Today (May 19 2009) gas prices are around $2.20/gallon (my guess is that this is on the low side).  This converts to 14.43% & 69.47% of average and small business employee discretionary incomes, respectively.  Or to put it succinctly, 50% of US employees have the discretionary budgets less gas costs reduced to $580 PER YEAR. That is definitely going to ripple through the economy as this is a reduction of consumer spending on other goods & services.

That means the small business employee is already feeling the pinch, and consumer spending of this 50% of the economy has already slowed down again.  We should see this coming through the economy in the next few months.  Also these numbers have not factored the 11 million newly unemployed. My guess is that a second slow down is in the works and should be visible by mid-summer.

Benjamin T Solomon
Managing Principal
QuantumRisk LLC

Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.

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