Consumers Spending Less Than Justified by Actual Income

Income and spending are both down, and it seems obvious that the one would lead to the other. But which one leads to the other? It's not so simple. Let's look at the data. (I only show the latest months, after the effect of the last stimulus plan had worked through the disposable income data.)

The drop in consumer spending is wildly disproportionate to the drop in disposable income. Keep in mind that when people lose jobs, their spending typically falls by a smaller percentage than their income drops. They use savings or credit to smooth their earnings. From this fact you might expect that the change in spending would be smaller than the change in disposable income. But the chart clearly shows the opposite. What's going on?

The change in spending is due to non-income factors (duh), which I think are primarily weak consumer attitudes and expectations. The consumer confidence and sentiment surveys show plenty of doom and gloom, caused by the fundamentals of rising unemployment, fear among people with jobs that they may lose their jobs, the financial crisis headlines, and the negativity from the election's attack ads.

(If you think the drop in spending was due to falling gasoline prices, you're right that gas sales fell, but non-gasoline retail spending is also down.)

The outlook for consumer spending is thus . . . positive. People are spending less than normal, less than justified by their actual incomes. Even if unemployment goes to eight percent, we'll still have 92 percent of the workforce earning a wage. The money not being spent will burn a hole in people's pockets. It will probably take a few more months of spending declines for this hole burning to take effect, so the economy hits its low point in the spring. The recession is over by the second half of 2009, perhaps a couple of months earlier.

Comments

[Enough Wealth:]

"People are spending less than normal, less than justified by their actual incomes" - you assume that what was previously considered to be "normal" was a sustainable ratio of spending to income . Over the past couple of decades consumer debt has been used to allow people ot spend more than their actual incomes, as shown by historically low (even negative) savings rates. That sort of profligate consumer spending was a boon to economic growth rates while it lasted, but was impossible to sustain indefinitely. Over-spending only continued for as long as it did due to the "wealth effect" of over-priced assets (real estate, equity markets). Now that several asset bubbles have deflated, people will be more concerned about the ratio of repayments to income. In this situation, it seems likely that spending will decline more than would be expected from looking at income levels in isolation. You can't make a convincing "all other things being equal" arguement when the world has just experienced a paradigm shift.

Jan 02 04:39 AM

[Moon Kil Woong:]

People have more disposable income if you assume they can freely spend 100% of their income and save nothing. This is mentality is endemic of this whole decade for the US. Strangely this contagion hasn't spread to the rest of the world or the US would be sitting with a whole lot of treasuries at auction and no buyers.

Many people naturally thought their homes could pay for their spending, household needs, maintenance, and retirement. Fortunately, they might have found out soon enough that they were wrong. Unfortunately, there are a lot of other people who are retired (by choice or by force) who have found out way too late that they were wrong.

Maybe after 10 years of austerity Americans can start going to the 2nd morgage till again. In the meantime that spare change is going towards credit card payment, piggy banks, or attempts to keep making mortgage payments they never could have afforded in the first place.

Graphs are decieving...

Jan 02 05:39 AM

[fotokemist:]

Perhaps the loss of personal credit availability has contributed to the cause of these data?

Jan 02 08:56 AM

[prudentinve...:]

Consumer spending in proportion to income, and in proportion to GDP, and in poportion to historic levels, has been abonormally high during the past 15 years. Savings have been abnormally low.

If we are to revert to normal patterns, spending will need to drop further and savings will need to rise.

Jan 02 09:04 AM

[M-P:]

This seems like a pretty simple analysis - more unidimensional. Per the other comments, the new "normal" should include more savings (we had a negative savings rate in the last couple of years), less credit card use (overall credit limits will be re-set), less home equity loans (people have been burned and banks are less willing), and more risk on the job front (risk = caution and less spending). We can't extrapolate from the last 3-5 years in terms of spending - as we are now seeing that it was all built on a house of cards that included high amounts of leverage, risk, and correlated bets. Personally, I don't see the same level of consumerism that we had - it was not sustainable.

Jan 02 09:22 AM

[bearfund:]

Aren't you overlooking the fact that spending has been at or above income for most of the last decade? Given the number of households with little or no savings, the number of households with high-interest debts as much as half their annual income, and the number of unemployed workers, I would say even today's slightly reduced level of spending is somewhere between optimistic and profligate.

Write it down and take it to your gold-filled safe: unless incomes start rising rapidly, consumer spending has a long way left to fall.

Jan 02 10:06 AM

[Eduard Fischer:]

It's kind of amazing that every comment posted here is more intelligently thought out than the original article. Dr. Conerly does not even seem to take into account the recent deflation of the credit bubble or the huge hole that was blown in the over leveraged banking system with the retreat of the real estate market. Or the even bigger hole that is going to appear in the credit system when another slew of ARM's start to reset in May and then these resets continue into 2012.

Jan 02 11:20 AM

[Still Renting:]

Ed, that is exactly what I was thinking. Odd.

Jan 02 11:46 AM

[Chris B:]

The consumer savings rate is reverting to the long-term mean, rising from 0% to about 10%. This alone can explain the widening gap between income and spending. As I've said before, these savings will come directly out of consumption, which is currently 70% of GDP, resulting in about a 7% decline in GDP before the effect of other factors. There is a decent chance that reversion to the mean will lead to an overcorrection, and the savings rate going to 15% or 20%. If that occurs, there will be a lot of retail space for rent and a lot of unemployed people.

Add in the following factors and you have a strong case for an overcorrection in the savings rate:

1) Baby boomer demographics. Their income and access to credit is about to dry up. Their retirement portfolios have just dropped 40% and their home value just dropped 15-20%. They have only a few more years of working and saving left that will have to fund the next 30 years of their retirement and the possibility of a difficult-to-recover-f... layoff is looming. Splurging on luxuries will not be a priority.

2) High consumer debt. What would happen if the average American cut spending and managed to pay off just 25% of their credit card debt this year? The result would be a trillion dollar tsunami that would swamp every retailer.

3) High student loan debt. Expect the 20-30 year old crowd to save the economy? Think again. Decades of 15% inflation in college tuition and the defunding of the Pell Grant program in the early 90's mean that many young people with college degrees have tens of thousands of dollars in debt to pay off. This plus the prospect of a layoff constrains their ability to take advantage of fire sales in retail, real estate, and investments.

4) Stagnant wages. You've heard the statistic before. Real wages (after inflation) have not increased in a decade. Where else could growth in spending possibly come from?

5) The Loss effect. Given the investment losses of 2008, the only way many small investors will be able to acheive their goals is by increasing their savings rate. Plenty of 10-year plans that assumed 7-10% YOY growth have become impossible to acheive. This is similar to the Baby Boomer effect but includes ANY investor with a goal, without consideration to the specific challenges facing Boomers.

6) Demographic Graying. Japan's high savings rate is partially due to the large number of retirees living on fixed incomes. The US is now approaching their demographic makeup. Simply put: old folks don't buy as much stuff as younger folks. Their income isn't high enough and they already have enough junk to last a lifetime!

Jan 02 12:22 PM

[Smarty_Pants:]

Any data on how much of 'income' is going to pay off previous debt?

If expectations of possible job loss are growing, a rational person would start paying down those credit card balances while they still had an income.

One only needs to take a long drive around your own town to see that there are a LOT more 'For Sale' signs sitting on expensive luxury items like autos and boats than you've ever seen before (not to mention the houses).

People are strapped for cash and unwinding the "good life" they've been living for the past several years with borrowed money. The new trend is going to be simplification and return to necessities until personal balance sheets are back in the black for a large portion of the country.

Jan 02 12:22 PM

[Moon Kil Woong:]

Haha Smarty Pants. I think the big question is: how much income is going to prevent more debt? Although the savings rate turned positive if assets like home values fall faster than your savings you in fact are still losing. Maybe even more than you were before when you were balooning your debt and your property value was not falling.

Now we know why people are a bit scared and are saving. Partially they are trying to offset their loss of asset value.

So since their home value falls their payments actually are under water and their debt is increasing even though the savings rates looks positive. They owe the same money but assets are lower so the differential is pure loss or debt now. Or better know as a giant mortgage sink hole.

Jan 02 01:15 PM

[Karen Consumer:]

This article makes as much sense as saying consumers are refusing to spend money just to spite economists.

Have you not heard of people being upside down in their houses, ARM's & Option ARMS resetting mortgage payments to double, and what about the layoffs?

Who vets these writers?

Jan 02 01:20 PM

[South Bay:]

This guy 'Bill Conerly' was predicting that the Sacramento housing market had bottomed about 6 months ago........continues to be wrong again.

Jan 02 01:23 PM

[Jason Rines...:]

Ditto. Phenominal comments all pointing out that America reverting back to Save and Invest.

On Jan 02 11:46 AM still renting wrote:

> Ed, that is exactly what I was thinking. Odd.

Jan 02 02:16 PM

[mrbill:]

Starting in '08 many people were saying our problems were psychological. Seems like this will be the theme for beginning of '09 as well. Let the shorting begin.

Jan 02 05:41 PM