In August, Personal Income rose 0.5% — a nice improvement over the 0.2% rise in July, and after being unchanged in June. This was the biggest increase since April (also up 0.5%). It was also well above the consensus expectation of a 0.3% increase.
Meanwhile, Personal Consumption Expenditures (PCE) rose by 0.4%, slightly higher than the consensus expectation of a 0.3% rise. That matched the July rise, is a significant acceleration from the unchanged reading in June and well above the rise of 0.1% in May and the 0.1% decline in April.
Of course, if income is rising faster than spending, it means that the savings rate is rising. It rose to 5.8% from 5.7%. The graph below (from http://www.calculatedriskblog.com/) shows the long-term history of the savings rate (3-month moving average).
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 then 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 s a causal relationship.
“The Paradox of Thrift”
In the short run, however, a rising savings rate slows down economic growth. 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). Staying home, instead of going out to eat, means that there is less work for waiters and cooks.
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. 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. 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.
Unfortunately, there is no way to go from a low savings rate to a high savings rate without the savings rate rising. 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, or at least they have over the last year or so. That progress, however, could be greatly undermined if the price of houses starts to go south again.
Personal Income Increases
The increase in Personal Income, while better than expected, was of only medium quality. In total, personal income rose by $59.3 billion, up from $22.0 billion in July, after declining by $2.7 billion in June (Seasonally adjusted annual rates, as are all the subsequent numbers on the components of personal income).
In August, private sector wages rose by $26.1 billion. In July, $25.7 billion of that increase came from private sector wages, while in June private salary income fell by $5.0 billion. Wages in the goods producing sector increased by $6.7 billion in August, up from $6.3 billion in July. In June, goods producing salaries fell by $8.5 billion. Wages in the private service sector were up at almost the same rate with and increase of $19.4 billion versus an increase of $19.5 billion in July, and an increase of just $3.5 billion in June.
Overall government wages (including the Census spending which is coming to an end), fell by $5.2 billion after rising $0.8 billion in July. A big part of the swing came from state and local governments, where total salaries fell at a $3.9 billion annual pace, after having increased by $2.0 billion in July. 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 $10.1 billion in August, on top of a $2.6 billion increase in July, but after falling $5.3 billion in June. However, more than all of that came from down on the farm, probably because the drought in Russia has pushed up prices for wheat.
Farm proprietors incomes rose by $5.2 billion, matching the increase in July. However, it comes after falling $0.2 billion in June. 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.
Non-farm proprietors income rose by $4.8 billion. It fell by $2.6 billion in July on top of a $5.3 billion drop in June. In other words, what we normally think of as small business income was really hurting, but is showing signs of getting back on track.
Farm proprietors income is tiny relative to non-farm at just $50.7 billion versus $1.01 trillion. Since June, farm income is up a stunning 25.8%. Perhaps Willie Nelson needs to find another beneficiary of benefit concerts.
Rental Income
Rental income rose by $2.5 billion in August, matching the July increase and up from a $1.7 billion increase in June. The strength in rental income is somewhat surprising given the very high vacancy rates that still prevail in most areas of the country for both residential and non residential properties.
Capital Income
Capital income, or income from dividends and interest, plunged by $11.0 billion in August on top of a $10.3 billion decline in July but after a $2.3 billion increase in June. This is the dark side of the low interest rate environment we are in.
This income is particularly important to retirees. They are finding that as their bonds and CD’s mature, they have to reinvest the proceeds at lower and lower rates. While both interest payments and dividends are income from assets, they tell a very different story.
Since January, interest income has fallen by $30.3 billion, or 2.5%, while dividend income is up $13.7 billion or 1.9%. Recently there have been several very large dividend increases announced (but not yet paid), including a first-ever at Cisco (CSCO) and a 23% increase at Microsoft (MSFT). That should mean a nice increase in dividend income going forward.
Income-oriented investors should emphasize dividend-paying stocks over fixed income. It is not hard to find big, solid companies that now have higher dividend yields than the 10-year T-note. Currently 139 of the S&P 500 yield more than the 10-year, and 89 of those do so with payout ratios of less than 60%. High and rising is better than low and flat.
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 were by far the biggest swing factor in the month, rising $35.8 billion in August, after only being up $0.5 billion in July. The reason was the temporary cut-off of extended unemployment benefits. Due to the Senate filibuster, millions were thrown off the rolls in July, causing income from unemployment benefits (both state paid and federal paid) to plunge by $17.1 billion, or 11.5%.
Benefit income rose by $20.6 billion in August, as the filibuster was overcome and the flow of income started again for those who have been out of work for more than six months. The other big category of transfer payments, Social Security, saw a $2.0 billion increase, down from a 10.8 billion increase in July.
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 (also from http://www.calculatedriskblog.com/).
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). Not 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 about 7%. We are now starting to see a very tentative recovery in it.
In Summation
Overall, I would have to rate this report as very positive. Both income and spending were up more than expected, and accelerated from previous months.
The quality of the income growth, on the other hand, was just OK. Private salaries showed about the same pace of increase as last month. There was a big positive swing in non-farm proprietors income.
Then again, a big part of the increase came from transfer payments. While that is still income that people can spend, and it is income that goes to those who are generally in most desperate need of it, it ultimately has to come from either taxes or deficit spending. Not a great report, but a marginally positive one, and we will take what ever good news on the economy we can get.
The big increase in PCE, rising $41.3 billion in August on top of a $41.4 billion increase in July (but after falling at a $4.0 annual rate in June), means that the consumer is likely to add to GDP growth in the third quarter (as the third graph shows, (also from http://www.calculatedriskblog.com/), probably about at a 2.0% rate. Since PCE makes up over 70% of the whole economy, having PCE growing rather than shrinking is extremely important.
Since we are not going to get a lot of support from the other areas of the economy, particularly residential investment and business investment in structures, as well as government spending, if the economy is going to grow at all in the third quarter, it will need a good showing from the consumer. So far so good on that front, but we only have two thirds of the picture.
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.
