The "Consumption Dysfunction" Continues
The latest reports from the Bureau of Economic Analysis on economic growth and personal income and spending have, on the surface, appeared to improve. Spending, as a percentage of the economy has just hit the highest level on record while economic growth is clipping along at a 2.2% annual growth rate in the first quarter. That is the good news. As we have discussed in the past the consumer is the key to this whole economic equation. As long as the consumer can consume, the economy can chug along. However, therein lies the dysfunction as well.
The first chart shows GDP on a 10 year rolling percentage change basis. That massive decline in economic growth 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 occured 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 is that if the system is flooded with cheaper dollars that 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 problem is that with the media viewing data from only one month, or quarter, to the next the long term trends are being missed. A good example is the most recent release of personal incomes by the BEA. The headline reported the personal income rose 0.4% in the latest month while spending rose 0.3%. The immediate headline was "Consumers spend less than they earned in the previous quarter." This sounds fantastic until you look at the trend of the data. The increase in spending of 0.3% was the lowest since last December and fell sharply from the 0.9% rise in February. This is the single biggest slide in spending since August of 2011.
Furthermore, while personal incomes increased by 0.4% for the month, the amount of government transfers increased by 0.5%. Currently there are more than 46 million people of food stamps. However, while that seems shocking enough in a supposedly growing economy, 35% of personal incomes are made up of government transfers. In the latest report government transfer receipts rose by $11.7 Billion. Government assistance has been on the decline in recent months as more individuals continue to fall off the extended unemployment benefits roll. The underbelly of the economy is growing with individuals that are no longer accounted for but are still part of the economic fabric.
For many Americans the real impact is declining income growth, less assistance and rising living costs. This substandard level of survival has consistently been under attack by sustained and rising inflationary pressures.
Rising oil and gasoline prices translate into higher food costs and prices at the pump which is an immediate and direct impact to the consumer. This becomes an issue for the economic outlook when the rate of income growth declines as food and energy costs subsequently rise. The deficit between income and expenses has to be made up somewhere. In order to maintain a current standard of living that gap has to be filled by decreased personal savings, increased debt or both. Over the past three months we have seen consumer credit expand markedly while personal saving rates have declined. This is an unsustainable trend that breaks sooner rather than later.
The personal saving rate, currently at 3.8%, is indicative of the problem. While personal saving rates could be bled down further to sustain the current level of subpar 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.