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Is the global current stock rally counting on more spending than the U.S.consumer will deliver?
08/04/2009 1:08 pm EST
Consumer spending, known to the government as “personal consumption expenditure,” fell at an annualized rate of 1.2% in the second quarter. That’s a bigger decline than government figures showed for the economy as a whole. In the second quarter U.S. GDP (gross domestic product) contracted at an annualized rate of 1%.
But why? One possibility is that the cause is temporary. Consumers are spending less because incomes are down because of the recession. And spending will bounce back quickly as incomes recover.
The other possibility is that the cause is a more long-lasting deleveraging of family balance sheets. In that case the economy is looking at a much slower recovery as Americans save more and borrow less.
How you answer this question goes a long way to deciding if 1) you’re skeptical of the current stock market rally now that it’s reached 1000 on the Standard & Poor’s 500 or 2) you’re still buying because this rally is based on a real global economic recovery and has a long way to go yet.
Let’s see what the numbers have to say, shall we?
First, there’s no doubt that falling incomes are a problem. Figures from the Department of Commerce released on the morning of August 4 show that personal incomes fell 1.3% in June. That was worse than forecast—economists were looking for a 1% drop—and the biggest decrease in four years. Inflation isn’t all that strong but it still cuts into the value of what you get in your paycheck. Including inflation, real personal income fell 1.8% in the month.
Second, despite the drop in personal income savings rates are rising.
There’s something a bit counter-intuitive to this. After all, if personal incomes are dropping, keeping up past levels of expenditure would require consumers to save less. The fact that they’re instead saving more while incomes are falling indicates that they’re cutting back on spending even more, enough to put more money into the bank even from a static or falling paycheck.
How much more? In May the personal savings rate climbed to 6.2%--a 14-year high, according to the Bureau of Economic Analysis. In June the savings rate fell back to 4.6%. But that’s still a huge increase from recent rates. The personal savings rate in the United States has been in almost continuous decline since the 6% plus annual rate of 1993.
In 2004 the U.S. personal savings rate dropped below 2%, according to the Organization for Economic Cooperation and Development, and it kept on sinking.
Third, U.S. households seem to be saving so they can cut their debt loads. I say “seem” because it’s really way too early to tell if the rise in the U.S. personal savings rate is a short-term reaction to the recession or the beginning of a long-term reversal of the drop in the savings rate since3 1993.
It’s logical to think that some of the increase in savings is a reaction to the uncertainties of a recession. If friends all around you are losing their jobs, you’re probably worried enough to put some more money in the bank just in case. (It’s a good bet that the families increasing their savings rate are those where the breadwinners still have jobs. I doubt that many families fighting to survive on unemployment checks are putting extra money into the bank.)
That kind of extra saving is a short-term response to the ongoing recession.
But it’s also logical to think, as I explained in my August 3 post, “It’s official: This is now the longest recession since the Great Depression. Here’s why that matters,” LINK HERE that the longer this recession goes on, the more it changes long-term behavior. The Great Depression produced a generation of savers who steered away from debt and credit cards. (My Dad, born in 1917, didn’t carry a mortgage, paid cash for his cars, and owned two credit cards in his entire life, one an Esso card he got for a cross-country driving vacation and the other a Sear’s charge card. (His one big vice was lawn mowers. He died with five in his garage.)
The longer the Great Recession lasts, and the more anemic the recovery, the greater the chance that it will produce a change in the current attitudes toward debt.
Consumers certainly have a lot of deleveraging—that’s what Wall Street and economists call paying down your debt as a percentage of your income--to do. In 1979, total U.S. household debt was 47% of U.S. national income or GDP. By 2007, when the current debt bubble burst, the figure had climbed above 100%.
There was a lot of debate during the run up to this figure about how much debt U.S. families could carry. The sensible conclusions that came out of that debate were that the debt ceiling depended on;
- income (if it was going up, families would pile on even a higher percentage of current debt in expectation of higher incomes in the future,
- asset prices (if the prices of stocks and homes were going up, families would add to their percentage of debt in anticipation of higher wealth in the future)
- the availability of credit (if credit card companies and mortgage lenders were pushing low cost debt—or at least debt with a low cost now—some families would add to their debt load).
It’s not certain how much de-leveraging U.S. households will chose to do—which is the same as saying how much money they’ll chose to divert from current consumption to current savings—but with incomes static and asset prices uncertain (despite the recent rally), I think the odds favor more deleveraging rather than less.
The third factor, the availability of credit, argues that U.S. families are going to be doing significant deleveraging whether they like it or not. Banks, in a classic “Lock the barn door after the horse has run away” move, have started to cut the supply of credit they’ll make available to U.S. families.
If you hold a credit card with any kind of balance, you’ve experienced this yourself.
One VISA card that I hold, for example, just upped my interest rate to 13.73% from 9.58%. And you know what I found when I shopped around for a lower interest rate? Every bank that offered a lower rate also wanted to cut my credit limit.
Some of my readers are small business owners who use their credit cards to manage cash flow. (I know you’ll find it hard to believe but some of these people actually believe in paying their suppliers promptly even though their own customers are, in this recession, dragging their feet about paying them.) One told me the story of a Visa card that he had that originally carried a $22,000 credit limit. Then the bank lowered the limit on the card to $17,000. Worried that his credit rating would take a hit if he went over that new lower limit, he paid off his bill, even though he didn’t have the cash flow to spare, to bring the balance safely under his new credit limit.
What did the bank do? It cut his credit limit again. And then, after he paid done the balance ever further, the bank cut his limit again. At this point, his original $22,000 credit line is down to just $9,000.
I think it’s fair to call this—whether it’s my experience looking for a lower rate credit card or my reader’s with his bank—forced deleveraging. And if forced deleveraging hits you, it really doesn’t matter whether you think you should lower your debt load as a percentage of your income or not, YOU WILL LOWER YOUR DEBT.
And, because, personal saving is calculated by the Department of Commerce as the difference between personal income and personal consumption, YOU WILL SAVE MORE.
I think that’s necessary in the long run. U.S. consumers can’t continue to spend more than they make and expect the savers in the rest of the world to send us money so we can keep shopping.
But as necessary as a higher savings rate may be in the United States, more saving and less spending by U.S. consumers is going to make this a slower and more uneven global economic recovery.
And right now I worry that this recovery will be slower and more uneven than the investors piling into roaring rallies from Shanghai to New York expect.
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