In July, personal income was essentially unchanged (up by $3.8 billion, or less than 0.1%). If one subtracts out taxes to get disposable personal income (DPI), it was also essentially unchanged — except it was a decline of $4.6 billion, but that is also less than 0.1%.
On the other hand, consumer spending, or personal consumption expenditures (PCE), increased by $25.0 billion or 0.2%. Well what happens if income is flat and spending rises? The savings rate falls.
In July, the savings rate dipped to 4.2% from 4.5% in June and from 6.0% in May. The rise in spending appeared to mostly be tied to the Cash for Clunkers program. Since it was only in effect for the last week of July, and for most of August, I would not be surprised to see spending rise again in August. I’m not sure about the direction of DPI.
The chart below (from http://www.calculatedriskblog.com/) shows the history of the savings rate, but uses a 3-month moving average to smooth out the fluctuations. Even with that, you can see that it is a pretty noisy series.
However, a few things are clear. First, the savings rate is still far above where it has been in recent years. The second is that we were on a relentless downward trend in the savings rate from the early 1980’s until the start of the recession. Prior to the mid-1980’s, it was rare to see the savings rate dip below 8.0%, but we have never gotten back close to that level since 1992.
A falling savings rate acts as a powerful tailwind for the economy. As people spend, they put money back into the economy, thus causing jobs to be created, which gives those people income that they spend and so on. The drop in the savings rate coincided with the rise in PCE as a share of the economy.
Over the long term, though, an economy cannot go without savings. Savings are needed for investments, and if they are not available domestically, then we have to find them abroad.
As a matter of accounting identity, the amount of capital we import is equal to our trade deficit. If savings are zero, then all the investments we make are ultimately being made by people abroad. Yes, there are a few intermediary steps in there, but ultimately that is what happens.
The rise in the savings rate is one of the key reasons that the Federal Government has been able to borrow at its current mind-boggling rate even as the trade deficit has been falling rapidly and has been able to do so without causing the interest rate it has to pay to rise significantly. In effect, with the savings rate higher, we have been able to borrow more from ourselves, rather than from the Chinese. The extremely low savings rates of the last decade are at the heart of the reason we owe so much abroad now.
Another thing to note is that the savings rate does tend to rise sharply in recessions. At first this seems to be counter-intuitive, since it is really hard to increase your savings when you are unemployed. Growth in DPI usually slows or turns negative in a recession, but not by as much as consumption does. The person who is out of work can’t save more, but his neighbor who fears he or she might be next tries to build up as much of a cushion as he or she can, so the overall savings rate goes up.
After all, even in the worst of times most people still have jobs. That was even true during the worst point of the Great Depression. The slowdown in consumer spending is a big part of the vicious cycle that makes a recession a recession.
Thus, we are sort of in a dilemma, over the long term — our low savings rate is totally unsustainable, yet in the short term a rising savings rate slows down the economy and causes unemployment to rise. Ultimately we need to get the savings rate up to the 9 or 10% level — that was the norm in the 1960’s and 1970’s. It will have to stay there for a prolonged period. We need for that to happen gradually or the economy will never climb out of its slump.
Indeed, I would argue that the somewhat better economic numbers we have been seeing in recent months are directly tied to the recent retreat of the savings rate. To paraphase St. Augustine, “Lord make us thrifty…but not yet.”
This long-term rise in the savings rate that is desperately needed should coincide with a decline in consumption as a share of the economy. In the second quarter, PCE was 70.6% of GDP, whereas back in the 1960’s and 1970’s it was less than 65% of GDP.
So what is going to make up that gap? Since GDP is made up of Consumption plus Investment plus Government plus Net Exports, we will have to see one of those three areas rise as a share of the economy. However, if people are keeping their wallets shut, it is not going to make a lot of sense for businesses to invest to expand capacity. This is especially true now with capacity utilization near post-war record lows (up slightly to 68.5% in July from a record 68.1% in June — 80% is normal — and it rarely falls below 75% even in bad recessions).
As I mentioned above, we have already seen a dramatic improvement in the trade deficit over the last year — more than cutting it in half. However, most of that improvement is due to the fall in the price of oil, and we are past the anniversary of the oil price peak, so that effect is going to fade. We have seen some pick-up in the economies of other major countries recently, but they are far from booming (with the exceptions of China and India, but even there things are going slower than they used to). That does not auger well for a dramatic increase in exports.
Thus, by process of elimination, it means that we will have to dramatically reduce our non-oil imports (or cut the volume of oil imports if we are not getting the help on the price side). The only other option is an increase in Government as a share of GDP.
This is a trend that has all sorts of implications. If we are going to be saving more, it should help investment management companies like Franklin Resources (BEN). On the other hand, if we are consuming less, it means that the consumer discretionary sector will face a particularly stiff headwind. People will take fewer vacations which will hurt airlines like United (UAUA) and hotel companies like Marriott (MAR).
Retailers, particularly in the mid-range like The Gap (GPS) and J.C. Penney’s (JCP) will find growth very hard to come by. Spending will not come to a stop, but it will slow, and people will be more concerned with cost as opposed to cash. This makes discounters like Family Dollar (FDO) relatively much better positioned.
Keep in mind here that I am talking about a trend that will play out over a decade, and it will not be a straight line, so from time to time some of the less-well-positioned firms might be good trades, but I suspect that they will be lousy long-term investments.
Read the full analyst report on “BEN”
Read the full analyst report on “UAUA”
Read the full analyst report on “MAR”
Read the full analyst report on “GPS”
Read the full analyst report on “JCP”
Read the full analyst report on “FDO”
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