In January, Personal Income rose 1.0%, well above the 0.4% rise in December, and a 0.3% increase in November. The increase was far above the 0.3% consensus expectation. However, most of the increase was due to the 2.0% cut in the employee side of the payroll tax.

Payroll taxes, and other contributions to social insurance, are counted as a subtraction from personal income. So if they fall, personal income rises. Of the $133.2 billion increase in overall personal income, $94.9 billion was due to the payroll tax cut.

Meanwhile, Personal Consumption Expenditures (PCE) rose by 0.2%, lower than the consensus expectation of a 0.4% rise. That is a deceleration from the 0.5% rise in December and a rise of 0.3% in November. The December increase in spending was revised down to 0.5% from 0.7%.

Of course, if income is rising faster than spending, it means that the savings rate is rising. Savings rose to 5.8% from 5.4% (revised from 5.3%). The savings rate is well above the dangerously low levels that prevailed from 2004 to 2008. The graph below shows the long-term history of the savings rate (unfortunately not updated with the January data yet at the St. Louis Fed Database).

Savings Rate & the U.S. Economy

Over the long run, a higher savings rate is good for the country, and is desperately needed as the savings rate has been in more or less a constant secular decline for the last 30 years. Without domestic savings, we have to borrow from abroad to invest in the economy.

Capital imports are the flip side of the trade deficit. If we sell less abroad than we buy, then we go into debt abroad. That is the same thing as importing capital. The chronically low savings rate has left the country trillions of dollars in debt to the rest of the world.

Note that in the 1960’s and 1970’s the savings rate was normally around 9 or 10%, and started a long secular decline after the 1982-83 recession. Prior to the 1980’s the U.S was the world’s largest creditor nation by a large margin. Now we are by far the world’s largest debtor.

The fall in the savings rate and the increase in our indebtedness is not a coincidence — it is a causal relationship. The extraordinarily low savings rates in the five or six years leading up to the Great Recession were a disaster for the country, even though it made things seem good at the time. We are paying the price for that party now.

In the short run, on the other hand, a rising savings rate slows economic growth, and vice versa. If someone gets a raise, but does not spend more, then that raise does not stimulate other economic activity. If the raise is not spent, then there is no increase in aggregate demand. It either increases future potential demand, or pays for demand that occurred in the past (i.e. debt is paid down).

On the other hand, if people are socking away less than they were for a rainy day, it increases current demand. If people go out to eat rather than stay at home, it means that there is more work for waiters and cooks.

Savings Rate Stabilizing?

The question is, will the savings rate stabilize here? The desire of consumers to sit on their wallets and not spend increases in income is very understandable. The collapse of housing prices destroyed trillions of dollars of wealth. That wealth people had been planning on using to finance their retirements or put the kids through college.

Housing wealth is (or at least was when the country still had it) far more “democratic” than stock market wealth. Personal housing wealth does not form the basis for large plutocratic fortunes, but rather more modest middle class nest-eggs. Now that money has to be replenished the hard way, by spending less than you earn.

Note how the savings rate tends to rise during recessions. The very fact that more people decide to save is one of the reasons recessions are, well, recessionary. While on an individual basis being thrifty is a good thing, and so is paying down your debt. However, if everyone decides to do it at the same time, it is a very bad thing. This is what Lord Keynes called “The Paradox of Thrift.” It is the change in the savings rate, not the level that causes the pain.

While the current decline in the savings rate is welcome for the short term, it is not healthy in the long run. We need more domestically formed capital, rather than relying on importing capital from abroad. Importing capital is the flip side of running a trade deficit.

The rise in the savings rate during the Great Recession was very rapid, and was one of the key reasons the recession was so severe. We are still a long way from the sort of savings rate we had back in the 1960’s and 1970’s, but we are a lot closer than we were a few years ago. Slowly people are making progress on repairing their balance sheets, but the damaged caused by the Financial meltdown of 2008 and the resulting Great Recession, was catastrophic. The process is being undermined by the resumed decline in housing prices.

Components of Personal Income

The components of Personal Income are as important as is the total number. As I noted above, the unusually large jump in January was primarily due to the change in the payroll tax. In total, personal income rose by $133.2 billion, a nice increase from the rise of $56.6 (revised from $54.6) billion in December (seasonally adjusted annual rates, as are all the subsequent numbers on the components of personal income).

Since the reduction in the payroll tax is only for one year, this is not a particularly high-quality source of personal income growth. On the other hand, it is probably of higher quality than government transfer payments (for example Social Security and Unemployment Insurance benefits). Those fell by $11.2 billion in January after increasing by $2.4 billion in December.

In January, private sector wages rose by $14.8 billion, down from a $20.8 billion increase in December. However, there was a big upward revision to the December numbers — they were originally reported as an increase of $15.5 billion.

Wages in the goods producing sector increased by $10.8 billion in January, up nicely from a $2.5 billion increase in December. Offsetting that, wages in the private service sector were up $4.8 billion versus an increase of $18.2 billion in December. Overall government wages, rose by $1.9 billion after rising $1.0 billion in December.

Private wages and salaries are the most important — and highest quality — form of personal income. Government wages have to be paid out of either taxes or government deficits. Government workers do, however, spend their money in the private sector, just like private sector workers do.

Proprietors Income

Another important source of personal income is proprietors income. In other words, what the self-employed and small businesses were earning. That increased by $3.9 billion in January, on top of a $8.2 billion increase in December. Farm proprietors incomes rose by $1.6 billion, on top of a $1.5 billion increase in December. Strong commodities prices have led to a stunning increase in farm incomes. Farm proprietors incomes have risen every month since March, and over that period they are up 64.9%.

The overall strength down on the farm helps explain why the Great Plains states like the Dakotas and Nebraska are weathering the downturn so much better than the rest of the country. It is also a good sign for firms that are tied to the farm economy, such as Deere (DE), Tractor Supply (TSCO) and Potash (POT). It also suggests that perhaps Willie Nelson needs to find a different recipient for his charity concerts.

Non-farm proprietors income rose by $2.3 billion, down from a $6.6 billion rise in December. In other words, what we normally think of as small business income is showing signs of getting back on track, but is hardly booming the way farm income is. Farm proprietors income is tiny relative to non-farm at just $58.6 billion versus $1.0339 trillion.

Since June, non-farm proprietors income is up a nice, but hardly exciting 2.6%. Non-farm proprietors income actually peaked back in December of 2006 at $1.1129 trillion, so small business income is still 7.1% below peak levels. On they other hand, it bottomed out in May 2009 at $971.6 billion, so we are now 6.4% above the valley floor.

Rental, Capital, Interest & Dividend Income

Rental income rose by $6.5 billion in January, up from a $1.9 billion increase in December. Rental income has increased every month since November 2009. The total increase since then is 12.3%. Given the still weak condition of the real estate market, this is somewhat surprising, but a sign that they are slowly on the mend.

Capital income, or income from dividends and interest, rose by $10.3 billion after it surged by $21.9 billion in December, and on top of a $17.3 billion rise in November. This income is particularly important to retirees. While interest rates are still very low by any historical measure, they have increased over the last few months, most notably longer-term t-notes.

Interest income increased by $2.1 billion in January after rising $13.6 billion in both December and November. This was the fourth month in a row of significantly higher interest income, but that only partially reverses earlier declines. Since June it is still down 0.3%.

Dividend income rose by $8.2 billion on top of an $8.3 billion increase in December after rising $3.6 billion in November. Dividend income can be a bit erratic month to month, but the general trend seems to be upwards, since June, total dividend income is up by 3.8%.

Government Transfer Payments

The final big component of personal income is government transfer payments. Like government salaries, this source of income has to come from either taxes or increased deficits and so it is a less desirable source of personal income from the point of view of the economy as a whole.

However, it is still income that gets spent in the economy. Wal-Mart (WMT) really doesn’t care if the money spent in its stores is from the elderly using their Social Security checks or the dividends they get from their investments, or really if it is retirees shopping there or people still in their working years spending their wages there, or their unemployment benefits.  Transfer payments fell this month by $11.2 billion, reversing an upward trend. They rose by $3.8 billion in December, after rising $8.7 billion in November.

Over the long term though, the economy cannot simply grow through ever increasing amounts of money being handed out by the government. Those payments are very useful in the short run to help hold up overall consumer spending when the economy has turned soft.

In the long run, the economy needs income from wages and salaries, and from small businesses earning profits. It is those earnings and profits that pay the taxes that support the transfer payments. It is then worth looking at personal income excluding transfer payments, as shown in the second graph. Since it is a long-term graph, inflation plays a much bigger role over time, and the graph is based on real personal income rather than nominal (which the rest of the numbers in this post are based on).

Note that during most recessions (and the immediate aftermath) incomes excluding transfer payments flatten out, but do not fall significantly. The Great Recession was very different in that regard, with income ex-transfer payments falling by 6.67%, in real terms, between 12/07 and 10/09. We are now starting to see a very tentative recovery in it, up 3.69% from the 10/09 low.



Report Card: C+

Overall, I would have to rate this report as slightly positive. Income was up much more than expected, the overall quality was only so-so. The biggest factor by far was the cut in the payroll tax, and that will go away next year.

On the other hand, transfer payments actually fell by a fairly significant $11.2 billion. If we factor out the impact of the payroll tax and transfer payments, then overall personal income was up $49.5 billion. That is down from a $57.7 billion increase in December, if similar adjustments are made.

The declining support from transfer payments is fairly significant if one takes a step back. The decline in transfer payments was 7.8% drag on total personal income growth while in December 9.7% of the increase in personal income came from higher transfer payments, down from 19.4% in November. Between May and October, 28.9% of the total increase in personal income came from higher government transfers.

Aside from the payroll tax effect, the increase in personal income is coming from sustainable sources like higher wages and salaries, most notably from the private sector, and from higher proprietors incomes. In other words, small businesses are starting to do better, even non-farm small businesses.

The higher income from interest payments is a bit of a double-edged sword, but is certainly welcome to retirees. Growth in dividend income is likely to continue as firms share their strong earnings growth with their shareholders. The increase in the savings rate is welcome over the long term, but is counterproductive right now in getting the economy back up closer to potential.

On the spending side, the report was a bit disappointing, up just 0.2%, down from a 0.5% increase in December, and below the 0.4% rise that was expected. The composition of the increase was also a bit worrisome. Of the total $23.7 billion increase in spending, just $4.1 billion of it went to durable goods, and spending on services actually fell by $2.0 billion.

Spending on non-durable goods, such as food and gasoline, made was up by $21.5 billion. That suggests to me that much of the rise was due to price increases in those commodities, not from growth in unit demand. That is something to keep an eye on going forward.
 
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