The decline in consumer spending will drag on the economy for a considerable period of time, even when the economy emerges from recession. It’s doubtful that the recovery will be particularly robust with credit tight and consumers strained.
Here’s a nice analysis of the consumers situation from the Quarterly Review and Outlook from Hoisington Management.
Going forward, the main problem for the U.S. economy is likely to be a protracted period of restrained consumer spending. In the expansion from 2002 to 2007, real Personal Consumer Expenditures (PCE), which comprised 71.5% of GDP at the end of last year, posted a 3.1% per annum increase, down from 3.5% and 4.2%, respectively, in the expansions of the 1990s and 1980s (Chart 2). The subdued gain in spending would have been even less had consumers lived within their means, as real personal income (2.5%) expanded less than the spending rate. With spending outpacing income, the personal saving rate dropped from 2.4% in 2002 to 0.4% in 2007.
A disparity of 0.7% per annum between the growth of income and spending might seem insignificant until you consider that income must also support all the other demands on consumers — investment in housing and other real assets, financial investment, and gifts to charitable and other causes.
The story of the past several years is how much the gains in the economy have gone to a few at the top. Instead of a rising tide lifting all boats, it has been a rising tide lifts a few yachts. It isn’t a healthy state of affairs for the American economy or society.
The main cause of the weaker trend in personal income in this decade was lackluster real wage and salary income that rose just 1.8%, or one-half the rate of gain in the expansion of the 1990s. This meager gain was caused by the sluggish .8% payroll employment growth rate that was the smallest of any expansion since World War II. With this key determinant of consumer spending restrained, consumers lived well beyond their means, only because their paper worth was boosted by surging home prices.
Families boosted their standard of living with women entering the workforce in droves starting in the 1970s. The rise of two income couples masked the slow growth of overall wages. In the ’90s and ’00s credit cards, home equity loans, and mortgage refinancing helped families increase their buying power. Much of the growth in debt reflected an attempt by families to keep up their standard of living at a time when incomes weren’t growing much. But now families are strapped trying to meet interest and principal payments, their savings are tapped out, their home values are crumbing. Debt is no longer an option for shoring up living standards. There isn’t another financial rabbit Americans can pull out of their hat.
The problem going forward is that real wealth is now declining, with the bottom yet to be found. Assuming home prices fall only 30% from their peak (some estimate a 50% decline), while stock prices rise 10% from the first quarter level and inflation is 2% per annum, the real wealth loss is about $7 trillion (Chart 4). Using the $1 to 7.5 cent ratio, this will constitute a drag on real PCE of 1.8% per annum from 2008 to 2010. Considering that the 3.1% rate of increase was the last expansion’s average, a 1.8% drag will be a 60% reduction in consumer spending growth over the next three years just from the cash out/wealth effect alone.
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