Why the Consumer Is Missing in Action
08/04/2009 2:30 pm EST
We know that the US consumer isn’t spending.
Consumer spending, called “personal consumption expenditure” by the government, 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, US gross domestic product (GDP) contracted at an annualized rate of 1%.
But why? Consumers may be spending less because their incomes are down because of the recession. In that case, spending will bounce back quickly as incomes recover.
Or there may be a more protracted deleveraging of family balance sheets. Then, we’re looking at a much slower recovery as Americans save more and borrow less.
How you answer this question will help you decide if: 1) You’re skeptical of the current stock market rally now that the Standard & Poor’s 500 has reached 1,000; or 2) you think this rally is based on a real global economic recovery and has a long way to go.
Let’s see what the numbers say.
First, falling incomes are a problem. Figures from the Department of Commerce released Thursday morning 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. 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 counterintuitive 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 they’re cutting back spending enough to put more money in the bank—even from static or smaller paychecks.
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, it fell back to 4.6%. But that’s still a huge increase from recent rates. The personal savings rate in the US has been in almost continuous decline since the 6%-plus annual rate of 1993.
Third, US 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 US 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 since 1993.
It’s logical to think that some of the increase in savings is a reaction to the 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 those fighting to survive on unemployment checks are putting extra money away.)
But it’s also logical to think, as I explained in my August 3rd post, 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 his entire life. 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 more likely it will produce a change in the current attitudes towards debt.|pagebreak|
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 US household debt was 47% of US national income, or GDP. By 2007, when the current debt bubble burst, it had climbed above 100%.
There has been a lot of debate over how much debt US families can carry. The sensible conclusions that emerged were that the debt ceiling depended on:
- Income (if it was going up, families would pile on an even higher percentage of current debt in expectation of higher incomes in the future)
- Asset prices (if the prices of stocks and homes were rising, families would add to their percentage of debt in anticipation of greater wealth in the future)
- The availability of credit (if credit card companies and mortgage lenders were pushing low-cost debt, some families would add to their debt load).
It’s not certain how much deleveraging US households will do—in other words, how much money they’ll 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 US families are going to do 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 US families.
If you have a credit card with any kind of balance, you’ve experienced this yourself.
One Visa card I hold, for example, just upped my interest rate to 13.73% from 9.58%. And when I shopped around, every bank that offered a lower interest 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. One told me he had a Visa card that originally carried a $22,000 credit limit. Then the bank lowered the limit 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.
So, what did the bank do? It cut his credit limit again. And then, after he paid down 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 savings 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. US 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 US, more saving and less spending by US consumers is going to make this a slower and more uneven global economic recovery than investors piling into stocks in roaring rallies from Shanghai to New York currently expect.