Over the past few years, consumer spending has been relatively robust even as the overall economy has maintained a fairly lackluster growth rate of just above 2%. In fact, consumer spending grew at an average pace of nearly 3% from 2014 to 2016 – over 0.7% better than the 2.2% average growth in GDP overall. The strength in consumer spending has been partially offset by weakness in either business investment, exports, government spending, or a combination thereof. Fortunately (for now anyway), consumer spending is by far the most important pillar to the economy as it has comprised, on average, about two-thirds of total GDP since 1980. Therefore, if consumer spending grows 3% in any given year, this single component of GDP would contribute 2% to overall GDP growth. As the consumer goes, they say, so goes the economy. So we thought we’d spend some time on some of the factors that complicate the process of analyzing consumer financial health.
Consumer spending is determined by the consumer’s means and willingness to spend. As relates to the means, consumers can derive spending power from several sources: earned income, investment income, savings, or borrowing. Data on income can easily be found from a variety of sources, both government and non-government. In general, though, much of the data has one problem in common: it is reported on either an aggregate or average basis. For example, the Personal Income data available from the Bureau of Economic Analysis is helpful if you want to track income trends for the entire population or even on an average per capita basis. However, tracking the data in this manner would fail to identify one of the biggest problems with our current economic recovery – growing economic inequality. In other words, the distribution of income is very hard to determine from the BEA’s headline Personal Income data. It could be the case (and in recent years it has been the case) that the overwhelming majority of income gains have been enjoyed by a very small percentage of well-to-do individuals. At the same time, the bulk of the population – the middle class – has enjoyed precious little income growth over the past 2+ decades, especially after adjusting for inflation.
We run into the same problem with the BEA’s spending data. It is very difficult to glean from the headline data exactly who is doing the spending. Through deeper analysis, it turns out that in recent years, the spending gains have been heavily concentrated among the same wealthy individuals who have enjoyed the strong income gains (from both their jobs and from their investments). Some economists have opined that as long as aggregate consumer spending is growing, it doesn’t matter who is doing the spending. We disagree. Wealthier individuals tend to save a larger percentage of their income than do moderate-income folks. Moreover, there comes a point when the wealthy simply cannot spend at the same pace as their income growth. (For example, in recent years the rich have earned hugely disproportionate investment gains from the stock market). This could be one reason why the savings rate has been trending higher in recent years. And as we all know, a higher savings rate is a drag on GDP.
There is another problem with the heavy concentration of income and spending at the top. The consumer inflation figures that are reported by the government each month (the Consumer Price Index, or CPI, by the BLS and the Personal Consumption Expenditures deflator, or PCE deflator, by the BEA) have suggested very subdued levels of inflation for the past many years. This low level of inflation has provided the cover for the Fed to maintain interest rates at ultra-low levels (which, incidentally, has juiced stock market returns). However, a deeper analysis of the inflation metrics reveals that relatively high inflation in non-discretionary categories like housing, health care, child care, transportation and education has been offset by relatively low levels of inflation in more discretionary categories. Why is this a problem? Because the bulk of the US population is getting squeezed by a combination of very weak income growth and rising costs for every-day necessities. As it relates to the health of the overall economy, this is very problematic because the very people most likely to spend money simply do not have any extra money to spend. In fact, a CNN Money article in January reported that “Nearly six in 10 Americans don’t have enough savings to cover a $500 or $1,000 unplanned expense, according to a new report from Bankrate.”
Finally, numerous articles in various publications in recent years have highlighted the growing problem of inadequate retirement savings. The vast majority of Americans simply have not saved nearly enough for retirement, and this is true despite a massive 250% increase in stock prices since the Financial-Crisis lows. As it relates to the economy, the worry is that these unprepared prospective retirees, including many Baby Boomers who will be retiring relatively soon, may have to start saving at much higher rates if they ever want to retire. This problem is compounded by the fact that stock valuations are currently high and interest rates are low, both of which translate to low relative returns in the future.
In sum, U.S. economic growth depends on consumer spending. The majority of consumers are not enjoying wage gains, and they are challenged by increasing costs for necessities and a need to save. The smaller part of the population that has benefited from high incomes and asset values can’t spend a lot more than they are currently spending. Therefore, economic growth has relied on a narrow base, the economic recovery has not been experienced equally, and the ongoing recovery will likely struggle until wage gains materialize for the middle class.