by Lacy Hunt and Van Hoisington, Hoisington Investment Management
The worst economic recovery of the post-war period will continue to be restrained by a consumer sector burdened by paltry income growth, a low and falling saving rate, and an increasingly restrictive Federal Reserve policy. Additionally, with the extremely high level of U.S. government debt and deteriorating fiscal situation, the economy is unlikely to benefit from any debt-financed tax changes. Finally, from a longer-term perspective, the recent natural disasters are an additional constraint on economic growth.
Nominal GDP has expanded by $712 billion over the past four quarters. Consumer spending, which was up $552 billion, represented 77% of this growth. For the past five years, consumers have accounted for about 68% of GDP, which is nearly identical to the average over the past 20 years. Clearly, consumer spending is a crucial component of maintaining growth in GDP. Consumer spending is funded either by income growth, more debt or some other reduction in saving. Recent trends in each of these categories, as outlined below, do not bode well for this critical sector of the U.S. economy.
First, in the past five years real disposable income growth (DPI) has averaged a disappointing 2%. Real DPI has been flat over the last three months and has risen only 1.2% over the past year. On a per capita basis over the past year, the growth rate is one-half of 1%, which is one-quarter of the historic growth rate. In nominal dollar terms, DPI has risen a paltry 2.7% over the past year. Consumer spending, in contrast, has risen much faster over the past year, growing by 3.9%.
Second, in an effort to maintain their standard of living in the face of slowing income growth, consumers stepped up their borrowing and significantly reduced their savings. In national income accounting, personal saving is calculated by subtracting personal outlays, including interest and transfer payments, from disposable personal income. As an example, in the past month personal income was $14.4 trillion (SAAR), with personal outlays of $13.9 trillion, resulting in total personal saving of $523 billion, or 3.6% of income. That is about three-fifths less than the 8.5% saving rate level that has existed since 1900 (Chart 1). As recently as five years ago the saving rate was 7.6%.
An increase in borrowing was the major factor behind the recent slide in the saving rate.
Consumer credit over the past year has risen by $208 billion, or 5.9%. Interestingly, without the drawdown in the saving rate, real consumer spending over the past two years would have been reduced by more than half. Considering the slow and declining rate of growth in income as well as the low saving rate, it appears that the current spending level cannot be sustained.
Historically there has been an important relationship between the saving rate and economic growth. A high initial saving rate has been associated with subsequently stronger economic growth, while a low saving rate produces a lower growth pattern. This observation can be confirmed by observing year-over-year growth in GDP plotted against the average of the current saving rate, with lags in the rate of one, two and three years (Chart 2). Since 1930 the regression coefficient indicates that a 1% drop in the personal saving rate in the current and prior three years will lower the real GDP growth rate by a substantial 0.65%. Considering that the present 3.6% saving rate is lower than all of the initial starting points of economic contractions since 1900, the outlook for ebullient growth is problematic particularly in the context of slow and diminishing income growth.