“3 Things” is a weekly post of thoughts I am pondering, usually contrarian, with respect to the markets, economy or portfolio management. Comments and thoughts are always welcome via email, Twitter, and/or Facebook.
Stop Blaming Consumers, They Can’t Help It
Since 2009, mainstream economists, the media, and the Fed have continued to prognosticate a resurgence of economic growth. Yet each year, as shown in the chart of Fed forecasts below, such predictions have repeatedly overstated reality.
Since the economy is almost 2/3rds driven by consumption, it was only a function of time before these same individuals, consistently wrong, lash out at those directly responsible for their shortcomings – the consumer. As noted by Robert Samuelson via The Washington Post:
“American consumers aren’t what they used to be — and that helps explain the plodding economic recovery. It gets no respect despite creating 14 million jobs and lasting almost seven years. The great gripe is that economic growth has been held to about 2 percent a year, well below historical standards. This sluggishness reflects a profound psychological transformation of American shoppers, who have dampened their consumption spending, affecting about two-thirds of the economy. To be blunt: We have sobered up.”
While Robert is correct about consumers not being what they used to be, he is wrong about the reasoning why.
Yes, the economy has created 14 million jobs since the last recession but it has not been the economic nirvana that such a number would seemingly reflect. This is because the majority of the jobs created have been in lower wage-paying industries which has suppressed overall wage growth which is lower today than it was in 2000. Furthermore, while 14 million jobs have been created, the working-age population has grown by 17 million.
Of course, the problem becomes more apparent when you realize that 1-in-5 families have ZERO members employed. In other words, it is not a lack of a desire to consume but an inability to do so.
This problem is exacerbated by the lack of wage growth since the turn of the century. As shown in the chart below, the 2-year average of median incomes in the United States, as reported by the Census Bureau, has fallen since the turn of the century and is now only slightly higher than it was in 1995.
Simply, it is hard to consume MORE, when you are earning less.
Of course, earning less is only one part of the problem. If you are earning less but the cost of maintaining a “standard of living” is rising, the deviation between incomes and outflows becomes more problematic.
There has long been a realization that inflation, as reported by the Government via the Consumer Price Index, is flawed. For the majority of Americans, the cost of living has historically been substantially higher than what the government reported it to be as rising healthcare and insurance costs, college tuition and taxes have sapped what bit of discretionary income may have been available.
Just recently Rob Arnott and Lillian Wu via Research Affiliates discussed this exact problem.
“Surveys suggest that the average American’s daily experience [of inflation] may be quite different. One-year consumer inflation expectations have been consistently higher than trailing and realized inflation over the last 20 years, and higher than more recent market-based inflation expectations, measured by one-year swap rates. Figure 1 shows how this divergence has grown larger since the financial crisis, suggesting the average household might have been feeling even greater pain during the recovery process than has been believed.“
“Since 1995, households have expected inflation to be, on average, 3.0%, whereas realized inflation has been around 2.2%, leaving an inflation “gap” of almost 0.8%. What explains this gap? The following is our hypothesis. The four “biggies” for the average American are rent, food, energy, and medical care, in approximately that order. These “four horsemen” have been galloping along at a faster rate than headline CPI. According to the BLS definition, they compose about 60% of the aggregate population’s consumption basket, but for struggling middle-class Americans, it’s closer to 80%. For the working poor, spending on these four categories can stretch to as much as 90% of total spending. Families have definitely been feeling the inflation gap, that difference between headline CPI and inflation in the prices of goods they most frequently consume.”
The second highlighted part of the quote above is crucial. For the middle-class and working poor, which is roughly 80% of households, rent, energy, medical and food comprise 80-90% of the aggregate consumption basket.
Despite claims by the current Administration that the “economy is back,” for a large majority of Americans they are in worse shape financially than they were eight years ago. As I wrote previously:
“While the mainstream media continues to tout that the economy is on the mend, real (inflation-adjusted) median net worth suggests that this is not the case overall.”
All Tapped Out
No. Consumers are most likely not saving more.
Recently, there have been many articles pointing to the rising saving rate, as reported by the BEA, as the reason why consumers are spending less.
As shown, the savings rate, while higher than it was in prior to the financial crisis, is still well below levels that would signify a more healthy household balance sheet. However, I suspect that even the current increase in the personal savings rate, as reported by the BEA, is wrong.
Given the lack of income growth and rising costs of living, it is unlikely that Americans are actually saving more. The reality is consumers are likely saving less and may even be pushing a negative savings rate.
I know suggesting such a thing is ridiculous. However, the BEA calculates the saving rate as the difference between incomes and outlays as measured by their own assumptions for interest rates on debt, inflationary pressures on a presumed basket of goods and services and taxes. What it does not measure is what individuals are actually putting into a bank saving or investment account. In other words, the savings rate is an estimate of what is “likely” to be saved each month.
However, as we can surmise, the reality for the majority of American’s is quite the opposite as the daily costs of maintaining the current standard of living absorbs any excess cash flow. This is why I repeatedly wrote early on that falling oil prices would not boost consumption and it didn’t.
As shown in the chart below, consumer credit has surged in recent months.
Here is the other problem. While economists, media, and analysts wish to blame those “stingy consumers” for not buying more stuff, the reality is the majority of American consumers have likely reached the limits of their ability to consume. This decline in economic growth over the past 30 years has kept the average American struggling to maintain their standard of living.
As shown above, consumer credit as a percentage of total personal consumption expenditures has risen from an average of 20% prior to 1980 to almost 30% today. As wage growth continues to stagnate, the dependency on credit to foster further consumption will continue to rise. Unfortunately, as I discussed previously, this is not a good thing as it relates to economic growth in the future.
“The massive indulgence in debt, what the Austrians refer to as a “credit induced boom,” has likely reached its inevitable conclusion. The unsustainable credit-sourced boom, which led to artificially stimulated borrowing, has continued to seek out ever diminishing investment opportunities.”
Ultimately these diminished investment opportunities repeatedly lead to widespread malinvestments. Not surprisingly, we clearly saw it play out “real-time” in everything from sub-prime mortgages to derivative instruments which were only for the purpose of milking the system of every potential penny regardless of the apparent underlying risk. We see it playing out again in the “chase for yield” in everything from junk bonds to equities. Not surprisingly, the end result will not be any different.
So, don’t blame those poor consumer’s for not spending – they are spending everything they have and then some.
Just some things to think about.
Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In