Savings, Consumption and the Economy: 'Lord, Make Us Thrifty, But Not Yet' 16 comments
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by Dirk van Dijk
Below are two graphs that look at the relationship between personal consumption and personal savings and GDP. The first looks at the year-over-year change in both real personal consumption expenditures (PCE) and real GDP since 1959. Overlaid on that is the personal savings rate. Note that there is a significant change in the behavior of the savings rate from about the mid-1980's onwards.
The second graph looks at personal consumption and savings as a percentage of GDP (this is somewhat different from the personal savings rate since it is a percentage of disposable personal income, not of GDP). The second graph starts in 1978 to better focus on the period after the savings rate started its secular decline.
Notice how closely correlated the change in PCE (blue line) is with the change in GDP (green line). This should not be a total surprise, since PCE has always been the biggest component of GDP. Also notice that the change in the savings rate is generally negatively correlated with changes in GDP growth, although the relationship is clearly weaker than the positive correlation GDP and PCE have with each other.
The GDP line is generally more volatile than the PCE series. Even though PCE currently makes up more than 70% of GDP, it tends to be the more stable part of the economy. Investment (including residential investment) is the part of GDP that tends to fluctuate wildly and causes booms and busts. However, if over time the blue line spends as much time below the green line as it does above it, the savings rate should generally remain stable and PCE should be a constant share of the economy.
Turning now to the second graph, it is clear that as the savings rate declined (to effectively zero), personal consumption rose as a share of the economy. In recent months we have seen a rebound in the savings rate. If it is sustained, it should over time lead to personal consumption being a smaller share of the economy.
If it were to, over the medium term (say 5 years), return to even the low end of the historic range, say 7.5% (late Reagan- through early Clinton-era levels), we should expect to see PCE decline as a share of the economy, perhaps down to as low as 65% or so. However, what will rise to take its place? Will businesses step up their investments in new plants and equipment? Why would they if the consumer is buying less?
Will we reverse the current account deficit and export our way out of this situation? That would be a nice solution, but most other economies in the world are also in distress and they are not likely to be dramatically increasing their consumption of the goods we produce. And what is it we produce again in terms of tradable goods?
I suspect for that to happen, the dollar will have to really plunge. Will the Japanese stand by as their industry is destroyed by an exchange rate of 60 yen to the dollar? Will the Germans be happy with a Euro that is worth $2? Recall that these are our creditors and hold lots of dollars, and they would see such a devaluation of the dollar as a partial reneging on the debt. Under standard GDP accounting, if Consumption is going to decline, and Investment is not going to rise and Net Exports are not going to rise, that means that either government spending is going to rise, or GDP is going to fall.
Let's suppose for a minute that PCE will fall to its mid-1980's level of 65% of GDP. How much of a decline would that take if the other components of GDP were to remain unchanged? Well, in the third quarter PCE was 70.5% of GDP. If it were to decline by 5%, it would -- all other things being equal -- reduce GDP by 3.53%, so that would not bring PCE down to the 65% level of GDP. Even a 10% reduction in PCE would only result in bringing PCE down to 67.2% of GDP, since it would be accompanied by an over 7% decline in real GDP.
In reality, it would require a 22.3% reduction in PCE to bring it down to 65% of GDP, provided everything else stays the same. In such an environment, it seems likely that Investment would not only not stay the same, but would also fall.
This recession has the potential to be much deeper and longer than is currently accepted by the majority of investors and the public. Without a well-designed stimulus package (and Government spending rising to take up some of the slack caused by falling PCE), this economy could be in extreme danger.
Even with a big package, we are in for a difficult time. I would avoid the entire Consumer Discretionary sector. This most certainly includes homebuilders like D.R. Horton (DHI), retailers like The Gap (GPS) and makers of toys for big boys like Harley-Davidson (HOG).
Just as Augustine prayed, "Lord, make me Chaste, but not yet," America needs to pray, "Lord, make me Thrifty, but not yet" -- or at least make us thrifty gradually.
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This article has 16 comments:
I'm not hearing much debate (except on SA) on how things got to this state, and why. Obama has bought the line that "all economists agree" that big govt spending is whats required. I would prefer to hear him first tell the world that America will get our financial house in order (pay down debt); that America will encourage savings over consumption; and that we will invest massively in new positive industries, especially alt energy. How to pay for it you ask? Well, lets see, the Pentagon is getting $700 billion this year...more than the military budgets of every other nation combined. China, number two spender on military, squeaks by on just $60 billion. America could spend the same amount of money, through the same companies (Raytheon etc), and have them produce wind turbines and electric cars, stuff the world actully needs, not multi-million $$ missiles to lob at some goat herder in some god-forsaken place totally unconnected to the real threats to our national security. Which is a bigger threat to US security, the collapse of the very fabric of our financial system, or some turban-head who can't even muster a proper army? 20 guys with box cutters (all from our Bush family friend Saudi Arabia BTW) can't possibly be taken this seriously.
This is not going to play out very well at all. After the holidays the box stores are almost empty. I don't want to go into specifics, but the manager of one major chain-box store told me that sales is off 74% year/over and that at this rate they can't pay for the electricity.
I was at a building-box store and they had one line open, and the self-check-outs. Not a single person buying anything. I'd bet they had more employees than they have shoppers.
There's no easy answer to this. You've had a massive credit bubble for 15-20 years based on thin assets, that inflated demand and prices for years. I'd bet that shopping space, based on a realistic supply and demand curve, if overbuit by 50-70% -- next shoe is commercial real estate.
If you want to know how bad things are, just observe your local retail or grocery store. It's not pretty and it's not going away in a few quarters or a couple of years. It's a deep-rooted structural problem that Obama, et.al. are not addressing.
Initially, savings will be use to retire credit card and equity debt.
Longer-term, we can hope that the increased savings will provide consumers a cushion, a means of retirement and additional funds for investment within the US.
A structural change in our economy is both required and needed.
On Jan 13 06:18 PM Socialism cannot compete! wrote:
> GDP will have to fall...because the government is already spending
> way beyond its means...and We The People are FED UP with the excessive,
> onerous taxation!! Let it happen...what is rotten must fall.
i did everything i could to prevent the collapse.
On Jan 13 03:45 PM Rokjok777 wrote:
> Obama has bought the line that "all economists agree"
> that big govt spending is whats required.
For instance, for someone who made $30,000 per year from 1970 to 1990, the combined "contributions" including the employer share grew by $1,710 because the total rate grew from 9.6% in 1970 to 15.3% in 1990 AND the ceiling increased from $7,800 to $51,300.
For someone who made $30K per year in that 20 years, it cost him $1,710 or $34,200 over the 20 years. IOW, the money was transferred from the potential payroll pool to the govt tax pool.
Again you can't overlook this when reviewing family savings rates IMO.
(And that would explain why savings dropped so precipitously in the 80's as more and more companies dropped pensions).
I suggest you go examine the Austrian economists for a clear and accurate explanation of our current mess. We need MORE savings, not less. We need REAL savings, not the pseudo type of fiat money induced inflation funneled into bogus pieces of paper wealth. We bought, borrowed, and bought more based on what is called the Real Balance effect, or the wealth effect. People felt "wealthier", which they were on paper, and then figured they could parlay that into more and more consumption. Aggregate demand will not increase simply because government throws money at people or puts them into bogus make work, temporary public works. If anything, that will forestall real recovery, real growth, and real investment - the real investment which is needed.
Firms need to lower their prices, which they have been, to clear out inventories. That will induce customers to purchase. It is simple and clear, that what we need is less government, more capitalism, more free markets, and less intervention. The more we save, the better. That only increases the pool of loanable funds, which will encourage real investment.
Bubbles are always unsustainable.
Please, please start your own blog and write your representatives. You are one of the few who gets it. Please enlighten others. Otherwise, we'll have an entire generation who will show the world what happens when Atlas Shrugs due to over taxation and regulation to pay for the bailouts that will solve nothing.
On Jan 14 01:47 PM Rob Mandel wrote:
> This is the paradox of thrift, and like everything else, Keynes was
> 110% WRONG. Consumption does not cause business cycles, but rather
> changes in consumption are the result of changes in investment spending.
> it is production that drives the economy. When the opportunity cost
> of investment falls, firms invest. The problem was the terrible easy
> money policies of Greenspan/Bernanke, the moral hazard of Freddie/Fannie,
> and incentivized debt/consumption cycle and malinvestment that created
> this bubble. No amount of consumption will create a recovery. No
> amount of government will "stimulate" the economy.
>
> I suggest you go examine the Austrian economists for a clear and
> accurate explanation of our current mess. We need MORE savings, not
> less. We need REAL savings, not the pseudo type of fiat money induced
> inflation funneled into bogus pieces of paper wealth. We bought,
> borrowed, and bought more based on what is called the Real Balance
> effect, or the wealth effect. People felt "wealthier", which they
> were on paper, and then figured they could parlay that into more
> and more consumption. Aggregate demand will not increase simply because
> government throws money at people or puts them into bogus make work,
> temporary public works. If anything, that will forestall real recovery,
> real growth, and real investment - the real investment which is needed.
>
>
> Firms need to lower their prices, which they have been, to clear
> out inventories. That will induce customers to purchase. It is simple
> and clear, that what we need is less government, more capitalism,
> more free markets, and less intervention. The more we save, the better.
> That only increases the pool of loanable funds, which will encourage
> real investment.
>
> Bubbles are always unsustainable.
www.washingtonpost.com...
We need infrastructure investment and other systemic change, of course, but we also need swift restoration of consumer confidence.
The 600,000 jobs lost last month represent only one sixth of the the total losses since the start of the recession. We need relief now, while all other plans take root.
Make us thrifty, but not yet!