It is a curious phenomenon that consumers are increasing spending in light of high unemployment and declining wages. How can that be? Have consumers just decided that the recession is over and life will be just like it was before?
Let's get the facts on the table regarding wealth, savings, earnings, and spending:
- Personal Consumption Expenditures increased 0.3% in February. Retailers had a good month.
- Unemployment (U-3) remains high at 9.7% nationally. Jobless claims keep rising: 24 states had rising rates, 9 had no change, and 17 had declining rates in last Friday's report. Note that the Washington DC corridor had wage gains.
- Private jobs are declining (-23,000) per the ADP report which is at odds with the BLS report.
- Wages keep declining. Real average hourly earnings for all employees fell 0.2 % from February to March. There was a 0.3-% increase in the average work week offsetting the decrease in real average hourly earnings.
- We also know that consumer credit continues to contract, a -4.0% decline YoY.
- About 51% of American households own stock, which which represents 36% of all equity holdings (.pdf) and 62% of all mutual fund holdings (.pdf) (2008). The rise in the stock market does create a wealth effect which makes people feel financially more secure. They were massive net sellers in 2008 (-55%).
- But, household net worth (.pdf) was up $2.8 trillion over 2008, about 5.4%, but it is still down about $11 trillion from the 2007 peak and now below 2005. The biggest drag was declining real estate values and declining equity in homes.
- Household debt measured by debt service payments as a percent of disposable personal income has declined from a peak of almost 14% to about 12.6%.
- As of Q4, household equity was 43.6% up from the record low of 40.8% in 2008, but below post-WWII levels. Part of the increase was due to a reduction in mortgage debt (defaults and pay-downs) not rising home prices.
- Foreclosure filings in the U.S. rose 16% YoY in Q1, and homes seized by lenders rose 35% YoY according to the latest RealtyTrac report. Auctions increased 21% YoY. They expect 1 million seizures and 4 million foreclosure filings this year.
- The Reuters/University of Michigan preliminary consumer confidence index of dropped to 69.5 in April from 73.6 in March.
- Personal savings has declined to about 3.2% down from a high of 6.4% in May, 2009. But savings has been declining since the early 1980s (about 12% then). Savings declined to an all-time low of less than 2% during the Dot Bomb crash.
To put this data into perspective, consumers are fearful about the future, unemployment remains very high, wages are declining and there is no way wages will increase any time soon, the home ATM is closed, consumers and small businesses can't get credit, and foreclosures are on the rise. While the stock market has gone up, household net worth is now back to pre-2005 levels.
So what is driving spending? Two things.
First is that consumers are drawing down savings to spend. Flat income growth caused consumers to tap into their savings to finance purchases of goods and services. If savings are a main motivation of consumers, especially with the wealthiest consumers (Boomers of retirement age), and since wages are flat to declining, then a reduction in savings to fund consumer purchases is not a good thing for the economy. It means that as soon as consumers feel they have sufficient income to continue to save, they will do so, and PCE (personal consumption expenditures) will remain flat for an extended period of time. The fact that they are dipping into savings is not healthy organic growth of PCE.
Second is the cash that is available to those consumers who have ceased paying their mortgage. Since foreclosures are at record levels, and since home owners understand there is no reason to pay their mortgage if they are going to lose their house, this frees up a significant amount of cash for PCE. David Rosenberg of Gluskin Sheff has estimated the effect to be $190 billion over time. While we can argue about his numbers, it doesn't represent a permanent source of income to fuel spending.
You may conclude that these factors are transitory, and that since long term economic trends favor saving over spending, PCE is systemically weak.
Further it appears that wage growth will remain stagnant. With such high unemployment there will be no pressure on employers to raise wages to attract workers. The economy needs to create 12 million jobs to recover to pre-recession levels. This may take three to five years depending on whom you listen to.
It appears that the economy has permanently changed and that consumer spending will not reach its former 70% share of GDP. If it does then that will be because GDP is shrinking in response to deflationary pressures, not economic growth.
Disclosure: No positions