In June, Personal Income rose 0.1%, down from a 0.2% rise (revised down from 0.3%) in May, and from 0.4% in April. The increase was in line with the consensus expectations. Meanwhile, Personal Consumption Expenditures (PCE) were down 0.2%, lower than the consensus expectation of a 0.1% rise. That is a deceleration from the 0.1% rise in May and the 0.2% increase in April.
Of course, if spending is falling and income is rising, it means that the savings rate is going up. The savings rate rose to 5.4%, up from 5.0% in May and 4.9% in April. The savings rate is well above the dangerously low levels that prevailed from 2004 to 2008 (although the annual benchmark revisions just substantially revised up the savings rates for those years).
The graph below shows the long-term history of the savings rate using a three-month moving average:
What the Savings Rate Means
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 is the 1960’s and 1970’s the savings rate was normally around 9 or 10%, but 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 to the rest of the world, 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.
A falling savings rate can give a very powerful boost to the economy, but only as long as it continues to fall. A low savings rate undermines the long-term economic strength of a country. In effect, it is a country having a feast on its seed corn. We are paying the price for that feast now.
In the short run, on the other hand, a rising savings rate slows 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).
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 home, it means that there is more work for waiters and cooks. If you are saving more seed corn to plant next year, there is going to be less to eat today.
Will the Savings Rate Stabilize?
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. It is the stuff of which modest middle-class nest eggs are made. 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. That might seem counter-intuitive, since it is very hard to save when you are unemployed, but it really isn’t.
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. We need more domestically formed capital, rather than relying on importing capital from abroad. Of course if we bought less from abroad, and more of our consumption was of things made here, we would also not have to borrow from abroad.
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. 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. That decline in wealth does not show up in the savings statistics, but savings have to compensate for it over the long term.
A Durable Recovery on the Horizon?
The progress that consumers have been making in shoring up their ability to meet their financial obligations can be seen in the graph below. The red line shows just debt service as a percent of disposable personal income, while the blue line is a broader measure that includes things like rent payments. This is an underappreciated sign that things are getting better and is setting the foundation for a more durable recovery.
The Income Statement of the “national household” is providing better coverage of interest (and similar) expenses. On the other hand, the decline in asset prices, especially housing, has left the balance sheet of the “national household” extremely leveraged. Of course that is an aggregate of all the households in the country, and does not apply to any individual household.
The components of Personal Income are as important as is the total number. There the news starts to get very bad. In total, personal income rose by just $18.7 billion in June, down from a $23.2 billion rise in May (revised sharply lower from $36.2 billion). That is well below the increase of $52.9 billion rise in April (seasonally adjusted annual rates, as are all the subsequent numbers on the components of personal income).
In June, total wages and salaries actually fell by $2.6 billion, down from increases of $14.5 billion in May and $26.9 billion in April. Private sector wages fell by $2.2 billion, down from a $15.0 billion increase in May and a $26.4 billion rise in April.
Wages in the goods producing sector fell by $1.8 billion in June, down from a $4.8 billion increase in May, and a $6.5 billion increase in April. Wages in the private service sector were down $0.3 billion versus an increase of $10.1 billion in May and a $19.9 billion rise in April.
Government Wages Keep Falling
Overall government wages have now fallen for two months in a row, dropping $0.4 billion in June after a $0.5 billion decline in May, and just a $0.5 billion increase in April. 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.
To keep the numbers in perspective, total private sector wages are 4.56x larger than total government wages. Since November, private sector wages have increased a total of $146.3 billion, while government wages have increased by just $2.1 billion, a ratio of 69.7x. Just where is all that “runaway government spending” we keep hearing about?
Remember these are nominal figures, not adjusted for inflation. The fall in both private sector and government wages in June, and the sharp deceleration from April and May, is a very troubling development.
Proprietors’ Income
Another important source of personal income is proprietors’ income. In other words, what the self-employed and small businesses were earning. That fell by $0.8 billion in June, down from a $0.6 billion rise in May and a $2.1 billion increase in March. The deceleration is all from the non-farm side, though farm incomes have been persistently weak over the last three months (albeit after a spectacular rise last year).
Farm proprietors’ incomes fell by $0.5 billion in each of the last three months. Don’t feel too bad for the farmers, though; since November, farm incomes are still up 12.1%. Strong commodities prices led to a stunning increase in farm incomes that is only partially being unwound. Weather is not helping out, with massive floods in some parts of the country, and record droughts in other parts.
Non-farm proprietors’ income (what is normally thought of as “small business” income) fell by $0.3 million, down from a $1.0 billion rise in May, and a $1.4 billion rise in April. In other words, what we normally think of as small business income is slowing down as well as wages.
Farm proprietors’ income is tiny relative to non-farm, at just $67.7 billion versus $1.0373 trillion. Non-farm proprietors’ income actually peaked back in December of 2006 at $1.1129 trillion, so small business income is still 6.8% below peak levels. On the other hand, it bottomed out in May 2009 at $971.6 billion, so we are now 6.7% above the valley floor.
Other Forms of Income
Rental income fell by $1.2 billion in June. It was down $1.3 billion in May and by $1.9 billion in April. Well, at least the declines are getting smaller. Still, not a good sign given that real estate has been at the heart of the current economic mess.
Capital income, or income from dividends and interest, rose by $12.0 billion in June, an acceleration from the $10.1 billion rise in May, but down from a $13.3 billion rise in April. This income is particularly important to retirees. Interest income has risen by $4.7 billion for three straight months now. Dividend income rose $7.3 billion, up from a $5.5 billion rise in May, but down from a $8.6 billion rise in April.
In other words, higher interest and dividend income accounted for 64.1% of the total increase in Personal Income in June, with higher dividends alone accounting for 39.0% of the increase. Yes, this is income that is particularly important. It is, however, also a source of income that overwhelmingly goes to the very top of the income distribution.
The top 1% now gets over 23% of all the income in the U.S. and that income is not coming just from high wages; it is in large part coming from dividends and interest income.
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 rose this month by $9.4 billion, way up from an actual decline of $1.4 billion in May but still far below the $12.5 billion rise in March. Among the more important parts of Transfer payment income are Social Security, where benefits rose by $0.7 billion in June, after falling $1.7 billion in May but rising $8.0 billion in April.
Unemployment benefits rose by $4.7 in June as unemployment rose; that, however, was after declines of $7.7 billion in May and $3.7 billion in April. There are lots of people who have not exhausted even their extended (Federally paid) unemployment benefits. At the end of this year, extended benefits will end altogether, unless Congress decides to extend them. Given the recent budget deal, that looks extremely unlikely.
Thus, come January, we are going to see a massive decline in transfer income. This is income that goes almost entirely to those at the low end of the income distribution. Medicare and Medicaid payments are also counted in the transfer payments, even though that is not income you can spend at the store.
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.
What We Need, Long-Term
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 blue line (left scale) shows we have not yet surpassed the level of total personal income ex-transfer payments we were at before the Great Recession. The red line shows that the year-over-year decline in such income was by far the steepest in modern history during the Great Recession. We are only about half way back.
Another Disappointing Report
Overall, I would have to rate this report as yet another big disappointment. After the GDP numbers came out on Friday, the downbeat report — and the downward revisions — were not all that surprising, though. However, the pattern of things getting worse and worse as the second quarter rolled on is very disturbing. It means that the economy has almost no forward momentum as we go into the third quarter, and what strength we had in the economy in the second qarter was all very early in the quarter.
Income was up, but less than expected, and last month was revised down. The quality of the income growth we got was awful. It was all either higher dividends and interest income, or higher transfer payments. A great deal of the higher transfer payments were from higher Medicare and Medicaid payments, which is not money people can go spend.
About half of the rise in transfer payments was higher unemployment benefits, and that is simply because more people are unemployed. We know that unemployment benefit income is going to sink like a rock in January, regardless of how many people are out of work. The poor in this country are about to get very poor.
Spending Side Also Down
On the spending side the report was also disappointing, with spending falling by $21.9 billion, down from an increase of $5.9 billion in May and from a $20.4 billion increase in April. The 0.2% decline was far below the consensus expectations of a 0.1% increase (and that was not setting the bar very high).
In other words, over the last three months, spending in nominal terms has increased by only $4.4 billion. That is a pretty good indication that the overall growth of the economy has slowed to a crawl.
The downward trend is just plain ugly. The consumer, which represents about 70% of the economy was simply missing in action in the second quarter. Spending on Goods fell by $19.8 billion in May, after falling $23.4 billion in May and a rise of $19.5 billion in April. Spending on durable goods is now down for four straight months. However the drop was “just” $4.5 billion in June after a 14.9 billion plunge in May, and a $3.1 billion fall in April.
Spending on non-durable goods has really decelerated, plunging $15.2 billion in June after a $8.6 billion drop in May and a $22.6 billion rise in April. If you want a silver lining, that drop probably in large part reflects the drop in gasoline prices.
Spending on Services has been erratic. It fell by $2.1 billion in June after rising $29.4 billion in May and just a $0.8 billion increase in April.
The report was very weak. This is more evidence that the recovery is losing steam. This is not the time to be tightening up on either monetary or fiscal policy. Unfortunately, it looks like the powers that be are intent on doing both.
Fortunately it looks like the cuts in the initial phase of the debt deal are back-end loaded, so the effect on the rest of this year will not be too dramatic, but they will have more of a bite in 2012 and beyond. Washington DC seems determined to repeat the mistake of 1937.
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