'Clunkers' Spending Siphons Savings

Includes: AN, F, KMX
by: Zacks Investment Research

In August, personal income rose by $19.3 billion, or 0.2%, and disposable personal income (or DPI, essentially after-tax income) rose by $15.5 billion, or 0.1%. The increase in personal income is essentially the same as we saw in July, and in line with consensus expectations.

DPI was actually down very slightly in July, so even the 0.1% increase is an improvement. Even though inflation is low, DPI is not keeping up with it. In real terms, DPI is down for three months in a row, having fallen 0.2% in August, 0.1% in July and plunging 1.6% in June.

Income from wages and salaries rose by $8.5 billion in August -- almost the same as the $8.6 billion increase in July -- however there was a big difference by sector. Service sector wages soared by $14.0 billion in August, a big increase from the $7.9 billion addition in July. Goods producers did not fare as well, with wages falling by $5.5 billion in August -- more than reversing the $0.7 billion gain in July. Within goods producing, the big swing was within manufacturing, where wages dropped $3.3 billion in August following a $4.4 billion gain in July.

While income was essentially stagnant, consumer spending (PCE) soared by $129.6 billion or 1.3%. This follows a 0.3% increase in July, or $25.2 billion. Real PCE -- PCE adjusted for inflation -- increased 0.9 percent in August, compared with an increase of 0.2 percent in July.

Purchases of durable goods increased 5.8 percent, compared with an increase of 1.8 percent. Purchases of Autos, in response to the "Cash for Clunkers" program, accounted for most of the August increase in purchases of durable goods, and more than accounted for the July increase.

If incomes are flat or rising slowly and spending jumps, it means that people are either drawing down on savings or going into debt. As far as these statistics are concerned, it doesn’t matter which.

The Cash for Clunkers program “succeeded” in getting the savings rate to come back down. In the short term, that is a good thing and has helped breath some new life into the economy. It was certainly good for Ford (F), CarMax (NYSE:KMX) and Auto Nation (NYSE:AN).

In the long term, however, this is a disaster. In August, personal savings (DPI minus PCE) was 324.1 billion or a rate of just 3.0%, down from $436.0 billion or 4.0% in July.

Our low savings rate and excessive dependence on consumer spending to power the economy is one of the key reasons the economy is in the mess it is in. It forces us to get the savings needed to invest in this country from abroad. It causes the trade deficit to soar. We end up buying goods from abroad rather than from domestic sources, and thus don’t see a lot of wage and salary income from manufacturing workers.

The graph below shows the path of the savings rate over the last fifty years. You can see that recently the savings rate has become very erratic (it is actually even more erratic than it looks since the graph uses a 3-month average to smooth things out) and while off the lows of recent years is still extremely low from a historical perspective.

A declining savings rate helps boost the economy, but a very low savings rate is unsustainable and eats away at the very core of its structure. It is sort of like eating your seed corn -- you enjoy it while you are feasting, but the next year you have a much smaller harvest. This country has been progressively eating more and more of its seed corn over the past 30 years or so.

As we try to replenish the seed, it means we have to eat less of the corn today so we can plant more for next year’s harvest. America will have to go on a diet -- but also not starve to death -- as we rebuild our seed stock.

Savings rates do tend to rise in recessions, but we need to get the savings rate back up to the 8 to 10% that was the norm in the 1960’s and 1970’s to restore the health of the economy for the long term. That means that consumption will have to become a much smaller part of the overall economy, and we will have to invest and export more. However, businesses are not likely to invest much if the consumer demand is not there. We will probably also have to see Government spending become a bigger part of the economy.

To paraphrase St. Augustine, “Lord, make us thrifty…but not yet.” The decline in the savings rate in August is going to be a big part of the reason why GDP in the third quarter will actually be positive -- perhaps by as much as 2.5% or 3.0%. However, that increase is coming at the expense of the progress we had been making in redressing one of the most important fundamental structural imbalances in our economy.

A long, slow, persistent rise in the savings rate is probably the best we can hope for -- one that results in positive growth, although slower growth than has been seen after most recessions.