After nearly 10 years, the US consumer is back to living on annual earned incomes. The debt funded cash flows made available by unrealized equity in houses and investment portfolios before that have been exhausted. This relationship is reshaping the short and long term demand curves for business’s goods and services.

A house and an investment portfolio are the available wealth generators that supplement consumers’ incomes and support purchasing power. They experienced sequential gold rush valuations over the last 10 years, allowing for vigorous spending habits under the premise that next year’s capital gains will pay for this year’s parade. After stiff retrenchment in these assets, and outright collapse if you were a shareholder of Nasdaq 5000, incomes have taken their rightful place at the wheel.

US business doesn’t know what 21st century GNP looks like when it’s produced primarily by earned incomes. Purchasing power for the decade was greatly distorted by the unrealized gains on consumer’s personal balance sheets. By 2006, a third of GNP was rightfully being estimated to have been from housing alone (e.g. construction materials and related labor, the mortgage fee chain from real estate agent to securitizing institution, retail sales).

It’s not reasonable to conclude demand will resume its former habits at the point houses have fallen back to where incomes can afford them and commodities settle into what they’re really worth to genuine users. When that equilibrium finds itself and banks are lending prudently again, it will be with a higher cost of living for consumers and their flat wage growth driving purchases. The unrealized gains have vanished. They are being replaced with realized losses to an as yet unknown extent.

Debt funded cash flows will have returned to levels that are commensurate with income profiles, instead of temporary asset price squeezes in the consumer’s favor. Thereafter, it’s hard to see significant support from measurable wage increases, as discussed in a prior post on inflation. If there is, we’ll have a worse time with the pass through of those payroll costs to consumers, such that any outsized wage growth will be lost to cost of living increases.

When economies creak and get edgy, say, when pictures of lines forming outside of banks become news, I recall an economics professor that animated the 101 subject level above its two dimensional context. He’s up at the dais introducing a new class of 18 year olds to guns and butter and how an economy is really a series of people paying each other on a next day basis.

My dollar payable is your dollar due and you’ll get it when I collect on the dollar owed me by another. But if everyone got tight and called in their money on the same day, we’d all get 20 cents on the dollar because that’s all that’s there, if everyone wants it at the same time. Though, if you can wait until tomorrow, you get a dollar.

I saw that by coincidence, Merrill Lynch found a buyer last week for much of its balance of damaged mortgage-backed assets, at 22 cents on the dollar.