Consumer Spending Leads To Lower Q2 GDP
In yesterday's report on GDP we stated that: "As you will see the consumer was weaker than originally estimated along with all the areas that the consumer directly effects - goods and services...What we are fairly confident of is that with the weakness that we have seen in the recent swath of economic reports is that the 2nd quarter GDP will likely be as weak, or weaker, than the first."
Today's release of personal income and spending confirmed what we previously expected - the consumer has been much weaker than previously believed. While personal income was modestly positive in May it was held back largely by earnings. Spending was even weaker on declines in auto sales and gasoline prices and was unchanged in May. The biggest declines in spending came in durables, down 0.4%, and non-durables, down 0.4%. Furthermore, the downward revisions of 0.2% for both March and April lead us to lower our estimates for 2nd quarter GDP to between 1.6 and 1.8%.
The stagnation of wages and salaries, a key component for long term economic recovery, continued as they remained unchanged. The large and available labor pool driven by a weak economy continues to keep a lid on wage pressures. The stagnation in wages contributes to a feedback loop of lower demand by consumers toward businesses. Lower demand keeps employment depressed. This deflationary cycle is very difficult to break.
The massive decline in economic prosperity has occurred even as consumption expanded from below 60% to over 70% of the economy. The belief is that expanding consumption should drive stronger economic growth. The reality is that the strongest economic growth occurred while spending and debt levels remained at lower ranges and saving rates were high. Savings lead to productive investment as money that is saved is lent to businesses for expansion or startup, real estate development, or the purchases of equipment. In turn, production is increased which leads to higher levels of employment and income. During the 60-70's savings rates ranged between 6% and 15% versus 3.7% today.
Today, the belief from ivory tower economists, Fed officials and the current administration is that if the system is flooded with cheaper dollars the near-term dysfunction of the economy can be fixed through a consumption driven recovery. The problem, however, as we just discussed, is that production must come first. Production is the real source of healthy consumption in the economy. The debt driven consumption of the 80-90's was a slow moving cancer through the economy. Debt has to be serviced which diverts and increasing amount of income away from savings and productive investment.
The decline in economic prosperity is readily seen by the more than 46 million individuals utilizing food stamps. Government policies, both fiscal and monetary, have kept employment highly constrained while increasing dependency on government welfare to support living needs.
The personal saving rate, currently at 3.9%, is indicative of the problem. While personal saving rates could be bled down further to sustain the current level of sub par economic growth - the world today is vastly different than it was prior to the last two recessions. Previously, access to credit and leverage were very easy to obtain to fill in the income gaps. Today, that is no longer the case which gives consumers relatively few options.
There is an old adage to never "count the consumer out." Individuals are very creative in finding ways to get the things they need to fulfill their lifestyle even when it is a detriment to their long term financial stability. However, there is a limit, or "wall," to the amount of the economy that the consumer can support on their own. This is why it is important to keep month to month variations in context with longer term historical trends.
Personal consumption is ultimately a function of the income available from which that spending is derived. As such, the current decline in the growth rate of incomes, without the tailwind of easy credit, poses a much greater threat to the current level of anemic economic growth than we have seen in past cycles.
The sustainability of the current economic environment is very questionable and is extremely susceptible to external shocks. This is why Ben Bernanke, along with the Federal Reserve, continue to reiterate an accommodative monetary policy stance. While these short term fixes may keep the economy from slipping into a recession in the short term - the long term consequences may be far more damning to the living standards of average Americans.