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Time to worry about the American consumer?

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Time to worry about the American consumer?

US economy

Time to worry about the American consumer?

Two basic ways to spend more money: you can earn more and save the same, or you can earn the same and save less. Newly revised data from the Bureau of Economic Analysis show that American consumers have spent the past two years embracing option 2. The average American now saves about 35 per cent less than in 2015:

Not since the beginning of 2008 have Americans saved so little — and that’s before accounting for inflation. It could be a sign of trouble ahead.

Start by looking at table 1B of the release. Employee compensation — wages, salaries, and benefits — was about 1 per cent lower in 2016 than previously reported. Government transfer income was also slightly down. Consumption spending, however, was about 0.5 per cent higher than thought. The net effect means today’s estimate of personal savings in 2016 is around 15 per cent lower than before. We knew the savings rate had dropped, but not as much as it actually did.

(Capital income was more or less unaffected by the revisions as personal interest income was much higher than previously believed, but this was offset by downward revisions to the income earned by partnerships and sole proprietors.)

Tables 2.6, 2.8.3, and 2.8.4 of the National Income and Product Accounts, which incorporate the fully-revised data, tell the story in more detail and at higher frequency. It looks worse that way.

Since the start of 2016, the average American has boosted spending on goods and services by a little more than 3 per cent, after adjusting for inflation. That’s significantly slower than in the recent past, although still relatively robust by the standards of this recovery.

By contrast, average real disposable income — income earned from work and asset ownership minus taxes plus transfers from government and businesses — has grown less than 1 per cent since the start of 2016. That’s the worst performance since the recovery began that can’t be explained by tax hikes:

Americans have made up the difference between mediocre spending growth and abysmal income growth by sharply reducing how much they save. The current gap between growth in consumption and disposable income is among the widest since the data begin.

The reason to worry is that, in the past, big disconnects between income and spending have tended to be driven by swings in consumption. Take out the occasional tax credit stimulus and Microsoft special dividend and disposable income is less volatile than spending on goods and services. (That’s the opposite of what you would expect if the financial system did its job of smoothing consumption, but never mind…)

Americans may have been irrationally exuberant in the 1990s and unwisely taking out three mortgages in the mid-1980s, but at least their financial incontinence could be identified with consumption in excess of what was reasonable. Today’s situation is one where consumption would have slowed into recessionary territory if not for the collapse in the savings rate. The one parallel is 2004-2007.

That isn’t sustainable. If consumption and market income keep growing at their current rates, interest burdens stay steady, and effective tax rates and transfer policies don’t change, then the savings rate will fall below zero by mid-2022:

There are lots of ways this situation could resolve itself. Labour and capital income growth could pick up. Fiscal policy could loosen up. Consumption growth could slow further, although that would also hit incomes unless some other sector of the US economy, possibly net exports to the rest of the world, picked up the slack. It’s extremely unlikely, however, that people will keep lowering their savings rate indefinitely. (It’s also unlikely consumer interest burdens will fall much lower than they already are, although it’s quite possible those burdens could rise.)

All that having been said, the recent drop in the savings rate may be less outrageous than it appears, even if it can’t go much further.

Recall that the BEA defines “saving” as disposable income minus the sum of consumption, interest excluding mortgage interest, and transfers paid to government and businesses. This is a reasonable definition that’s consistent with international standards but it can sometimes make reasonable behaviours look imprudent.

After all, the whole point of saving is to have money available to support consumption in the future. If you save by buying assets that appreciate in value, there isn’t necessarily anything wrong with spending some of the capital gains on goods and services every once in a while, especially if you’re experiencing what you think is a temporary slowdown in earnings growth.

Whether or not you finance the extra spending by cutting the amount you spend on additional assets, borrowing against those assets, or selling down your position, the extra spending relative to earned income shows up as a decline in the savings rate — even if you’re better off than you were before.

Net worth relative to disposable income tends to move inversely to the savings rate. This ratio is currently at its all-time high because American household net worth has soared by about $7.2 trillion — a little more than 8 per cent — since the start of 2016. From a certain point of view, therefore, the decline in the savings rate isn’t worrisome but the logical outcome of asset price movements.

The unanswered question is whether the drop in the aggregate savings rate is actually being driven by people who have gotten richer, or instead by those struggling to sustain their expenses in the face of stagnant real incomes. Most wealth is in the form of financial assets owned by a sliver of the population. Are they really the ones holding up the aggregate consumption data? If not, how much longer can America’s dis-savers sustain this expansion?

Related links:
Americans Aren’t Saving Money Like They Used To — Bloomberg
How has BEA revised personal saving and the personal saving rate over time? — BEA FAQ

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