Revisiting the Financial Health of the Consumer

One thing I hear continually in the financial media is that the consumer has a strong balance sheet and is therefore relatively healthy from a financial perspective. The pundits usually use some combination of the following in their arguments: consumer debt levels have moderated relative to GDP; excess savings accumulated during COVID are still high; the labor market is still very tight, and wages are growing at a robust pace; and aggregate household net worth has blown out to the upside. Some of these points are valid, but some require a more nuanced evaluation. Today I would like to play devil’s advocate and pose some questions, the answers to which, I believe, paint a more sober picture regarding the financial health of the US consumer.   

1. If consumers are awash in savings, why has consumer debt, particularly credit card debt, been surging? Yesterday, we learned from the Federal Reserve Bank of New York that Americans are collectively carrying $1.08 trillion in credit card balances. Further analysis of Federal Reserve data shows that outstanding revolving credit has been growing at double-digit rates for the past 19 months after dropping during the initial stages of COVID. It’s worth noting, as well, that consumers are falling behind on their credit card, auto, and housing debt at much higher rates than 1-2 years ago. For now, bank executives believe the spike in loan delinquencies is simply a normalization of credit metrics back to pre-COVID levels. But can we be sure? How dependent on his/her credit cards is the middle-class consumer?

2. Why has the consumer savings rate (savings divided by disposable personal income) dropped to less than half of the average since 2010? Do consumers save more or less when their finances are tight?

3. When evaluating the financial health of consumers, should the consumer get credit for cash that was given to him/her by a federal government that had to borrow in order to fund the distributions? I have made this argument for a long time. In my view, it’s not sufficient to simply examine the consumer’s balance sheet in isolation. The federal government’s borrowing will eventually have to be paid back by taxpayers. And so, the federal government is the consumer and vice versa. The several trillion dollars in transfer payments that went to consumers during COVID are reflected as a surge in government debt. As the chart below shows, the combination of household and federal government debt as a percentage of GDP (represented by the green bars) was at 176% in the 2Q23 – well above levels that prevailed before COVID. Much of the increase is due to the federal government’s decision to send out checks as financial support during COVID. 

4. Perhaps the best argument in favor of the “healthy consumer” position is the fact that aggregate household net worth has surged to over $154 trillion in the 2Q23 – up a huge $38 trillion (or 32%) in just 3.5 years (since before COVID arrived). But what if the assets on the consumer’s balance sheet are inflated? If the assets are inflated, then the dramatic increase in household net worth since COVID began could be inflated, as well. And if the $38 trillion surge in net wealth contributed to economic growth through higher consumer spending, otherwise known as the “wealth effect”, then shouldn’t we expect the opposite to happen if/when household net worth declines? My worry is that consumers could be vastly overestimating the amount of equity they have in their house because mortgage rates have risen so much. As I write, the housing market is in a deep freeze due to a dearth of supply, which is supporting prices for now. But eventually some people will inevitably have to sell for various reasons, with one notable bank analyst (Meredith Whitney) saying yesterday that the selling may be triggered by baby boomers downsizing their homes. Whatever the catalyst, the housing market is likely to unfreeze at some point, and it’s likely there will be a surge of supply hitting the market as people start to fear that their equity is evaporating. When that happens housing prices could fall materially, likely leading to a thriftier consumer and a drag on the economy.

5. Finally, I have to make the argument I always make, which is that the lion’s share of the aggregate consumer savings, income and wealth is concentrated among the wealthy. The rich have a lower marginal propensity to spend, so we shouldn’t expect strong consumer spending to continue if current trends continue. 

The US consumer has been heavily supported by a federal government that distributed a massive amount of cash during COVID. These funds lasted longer than most (including me) expected but are now running low. At the same time, there are now clear indications in the bond market that investors do not want to see the continuation of profligate spending by the federal government. This poses a big problem for policymakers at a time when monetary accommodation is being removed at a rapid clip. A strong labor market is supportive for now, but will that continue if and when consumer demand for goods and services begins to suffer from financial stress? That’s the $30 trillion question. From where I sit, it still seems a recession will be hard to avoid given the fiscal and monetary headwinds. But so far, I’ve been wrong!

Remain defensive amid increased volatility and uncertainty.