This morning’s report on Personal Income and Spending was a classic good news and bad news report.
First, the bad news: Personal Spending, or what is known as Personal Consumption Expenditures or PCE, was virtually unchanged (up $4.0 billion, which does not even round to 0.1%) in April after rising a very robust 0.6% in March. PCE is kind of on the important side, since it accounts for 71% of the U.S. economy. To some extent, the early Easter might have pulled some spending into March from April, thus inflating PCE of March and depressing it for April, but that would not account for all of the swing.
This is evidence that consumers were spending much less freely in April than they were in March. It also would tend to indicate that GDP growth in the second quarter will be significantly lower than the 3.0% rate of the first quarter (in addition to the drag from the inventory replenishment cycle being mostly over).
Now, for the good news: Personal income rose by 0.4%, and the growth in personal income for March was revised up to 0.4% from 0.3%. If income is rising faster than spending is rising, then the savings rate is going up. While the savings rate of 3.6% is significantly higher than the 3.1% rate in March, it really is far too low for the long term health of the economy.
The problem is that a rising savings rate tends to slow the economy, but a low savings rate means that for the economy to be able to invest for the future, it has to import capital from overseas. In other words, it has to run a trade deficit. That is not an opinion, that is an accounting identity.
Unfortunately, there is no way to go from low to high without going up. The least painful way for it to happen is for personal income to rise faster than PCE, but for both of them to be rising.
Behind the Headline Numbers
The sources of Personal income were also much healthier in April than in March. Of the total $57.6 billion of higher personal income, $24.4 billion or 42.4% came from higher private sector wages and salaries. In March only $13.7 billion, or 29.3% of the total $46.7 billion increase came from private sector wages.
Wages in the goods-producing sector increased by $5.8 billion vs. a $4.1 billion increase in March. That includes a $4.5 billion gain in manufacturing wages in April and only a $1.6 billion gain in manufacturing wages in March.
Service sector wages increased by $18.6 billion in April up from a $9.6 billion gain in March. Government wages, on the other hand, increased by just $1.9 billion instead of $2.9 billion in March.
Proprietor’s incomes, which are a good measure of how small businesses are doing, showed a $13.6 billion increase versus a gain of just $4.0 billion in March. However, most of that improvement came from down on the farm, as farm income rose by $3.8 billion, as opposed to declining by $5.0 billion in March.
Non-farm proprietors income showed an increase of $9.8 billion on top of a $9.0 billion increase in March. The rate of growth of rental income slowed significantly to a gain of just $0.5 billion from a $2.8 billion increase in March. Given the very high vacancy rates in both apartments and most forms of commercial real estate, it is sort of surprising that rental income is going up at all.
Two Big Swing Factors
There were two huge swing factors in personal income in April, but they were headed in opposite directions. In March, dividend and interest income had dropped by $13.4 billion, which was more than reversed with a $18.9 billion increase in April. Some of that swing might just be normal seasonality. After all, most dividends are paid quarterly, and the swing might just have to do with when which companies pay their dividends.
In general, though, this source of income has been under pressure from very low interest rates. While low interest rates help stimulate investment and get the economy rolling again, they are not good news for those who live off of interest income, such as many retirees. A fixed income is not all that fixed if the 4% CD you had matures and you have to roll it over into a 2% CD.
The other huge swing factor was personal transfer payments. Those are the government checks people get, including social security and unemployment insurance. After a massive $35.4 billion jump in March ($18.6 billion of which had to do with extended unemployment benefits), those payments actually declined by $4.8 billion in April. Thus the increase in income coming from the private sector (i.e. backing out the change in transfer income and in government salaries) was $60.5 billion versus just $8.4 billion in March. That is a very healthy development.
Personal Income Is Key
Personal income is, of course, the primary source of funds for personal spending. The fact that it rose faster than spending means that the consumer is making some progress on repairing their balance sheet and will be in a better position to spend in the future. It also means that we have more money in the system available for investment without having to import capital. “Importing capital,” by the way, is another way of saying “going deeper in debt to the Chinese” or selling off assets to them.
For the long term, that is a very positive development and one that needs to continue for a long time to come. As the graph below (from http://www.calculatedriskblog.com/) shows, the personal savings rate jumped sharply as the recession hit, but has been generally falling in recent months (the graph shows a 3-month moving average, so the increase in April is not that evident).
We want to see incomes grow faster than consumption, but we also want to see some growth in consumption. At 71% of the economy, if consumption does not grow, GDP does not grow. We want to see PCE fall as a percentage of the economy, but not see it drag down the size of the economy overall as it happens. It is a tough balancing act.
The up 0.4% on income and unchanged on PCE was not ideal, but in the long run, it is actually much better than what we saw in March, with PCE rising by 0.6% and income up by 0.4%. Ideal (and within the realm of realistic possibility) would be something like income up 0.5% and PCE up 0.2%, and those sorts of rates sustained for a long time.
The savings rate always tends to rise during recessions. Indeed, a rising savings rate helps exacerbate recessions by lowering overall demand. As demand falls, people are laid off and then income falls, which then leads to even less demand and the cycle continues. While increasing your savings is personally virtuous, if everyone does it at the same time, the result can be a very big slowdown in economic growth. This is what is known as the “paradox of thrift.”
Conversely, if the savings rate falls, it can give economic growth a big boost. From 1981 to the start of the Great Recession, the savings rate has been on a secular decline. In the 1960’s and 1970’s, savings rates were normally between 8 and 10% — a bit higher in bad times, a bit lower in good times. By the early 2000’s they had fallen well below 2%.
That decline provided a massive tailwind for economic growth. It coincided with a big increase in the percentage of the economy that is devoted to consumption and the massive increase in the trade deficit. That is not just a coincidence. Essentially, as a country, we have been emptying out our bank account over the years, and running up the credit card to pay from oil form OPEC and the assorted stuff on the shelves of Wal-Mart (WMT) that is made in China. To the extent we needed to invest, be it in new plants and equipment or in aircraft carriers or new houses, without the savings in the bank, we had to borrow those funds from abroad.
That is not a process that can go on forever, and the savings rate is going to have to be on a secular increase. As a result, the economy is now going to face a long-term headwind to growth. At times it will be like a gentle breeze and at other times it will gust much higher, but as long as the savings rate is headed upward, economic growth will be slower than what it otherwise would have been.
We did not get into the low savings mess overnight — it took us about 30 years to do so. We will not get out of it overnight either, nor would we really want to. Just think of the economic damage that was caused as the savings rate started to shoot up starting at the end of 2007. We need a long, slow — but relentless — grind upwards in the savings rate to solve the problem.
The Short View and the Long View
In the short run, today’s report is disappointing and points to a significant slowdown in economic growth in the second quarter, unless other sectors of the economy can pick up the slack from the slowdown in PCE. However, given how big PCE is relative to all the other parts of the economy combined, that is going to be tough for them to do.
In the long term, it is very good news that we are gradually restoring the savings rate to a sustainable level. Also the sources of personal income were much healthier in April than in March. That is very important, since as the second graph shows, the overall composition of income had been getting much less healthy. It shows the growth of income that comes from mostly private sector sources, not from transfer payments like Social Security, and does so adjusted for inflation.
The Great Recession saw a much larger decline in this measure than any previous downturn, by a fairly wide margin. Over the last year it has stabilized, and in April it showed a sharp increase. However, there is still a very long way to go, and the April increase is barely visible on the graph. Let’s just hope that April is the start of a trend that lasts a long time.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.
