In February, Personal Income increased by $1.2 billion from January. That is essentially unchanged, as the increase does not even round to 0.1%. In contrast, personal consumption expenditures, also know as PCE or personal spending, rose by $34.7 billion or 0.3%.
If spending rises by more than income, naturally savings will fall. Personal spending in February fell to a seasonally adjusted annual rate of $340.0 billion, down 9.3% from January’s rate of $374.9 billion. The savings rate fell to 3.1% from 3.4%. Relative to consensus expectations, personal income came in a tick lower than the 0.1% increase expected, while PCE was in line with expectations.
On both spending and income, the February rate was a slowdown from the revised January increases of 0.3% for income and 0.4% for PCE. However, on both fronts the January numbers were revised. Originally, personal income was reported as up just 0.1% while PCE was reported up 0.5%. The savings rate in January turns out to have been higher than we thought it was, as a result. Thus, while on first blush the February report appears to be mildly disappointing, it was roughly in line with expectations after the revisions are taken into account.
Personal Spending at a Decent Pace
The increase in PCE is at a pretty good clip, and implies an increase of about 3.0% for the first quarter, or at least that is the pace we are on for the first two thirds of the quarter. PCE is by far the largest part of GDP at about 71% of the whole economy in the fourth quarter. It was only a minor contributor to the 5.6% growth in the fourth quarter, though, responsible for only 1.16 points of that growth.
Most of the growth in the fourth quarter came from a slower pace of inventory liquidation. If the 3.0% PCE growth pace holds for all of the first quarter, it would imply a contribution of 2.13 points of growth in the first quarter. While the contribution from inventories is not going to be as big in the first quarter, these numbers do imply fairly healthy GDP growth.
On the other hand, as the graph below (from http://www.calculatedriskblog.com/) shows, the savings rate is already at a very low level, and is now falling sharply again (the graph shows a 3-month moving average for smoothing, so the level shown is higher than the February rate; it is actually worst than it looks in the picture).
While the savings rate has risen substantially from the very low rates of a few years ago, we still have one of the lowest savings rates in the industrialized world, and are far below what was considered normal and healthy in the 1960’s and 1970’s or even the 1980’s. A falling savings rate helps goose the short-term growth of GDP, but a low savings rate means that we have to import capital to finance our investments.
Importation of Capital
That importation of capital is the flip side of the trade deficit. That importation of capital shows up in the huge amount of t-bonds being held by the Chinese Central Bank and by OPEC. If we had a higher savings rate, our budget deficits would be financed internally, the way they largely were in the past.
That is roughly the situation that Japan is in. It has run budget deficits far higher than ours (as a percentage of GDP) for a long time now, and their government debt relative to GDP is much higher than ours. However, that debt is largely owed to its own citizens. The same was true of the U.S. government debt after WWII. It was much higher than it is now, or even than it is projected to get to by 2016 even with the big current budget deficits. However, we owed it to ourselves then, not to the Chinese, the Arabs, or even the British or Dutch.
In a closed economy (no foreign trade at all) savings would equal investment, and we would not have nearly enough at current rates to finance it. This is investment, broadly speaking, including residential investment, the biggest part of which is new home construction. We would not have the cash to invest in new plants and equipment. That would mean almost no domestic orders at all for firms selling capital equipment, ranging from high tech firms like Applied Materials (AMAT) to more traditional capital equipment like heavy trucks made by Paccar (PCAR).
Without investment, eventually economic growth would slow to a crawl, even though the falling savings rate would be temporally boosting the GDP growth rate. Importing capital has allowed economic growth to go forward, but at a cost to our national sovereignty. We are greatly constrained in how we deal with China by the fact that they own over $2 trillion of our paper.
As I pointed out last week (see Health Care & Consumption) the rise in consumption as a share of GDP has paralleled not just the decline in the savings rate, but also the increase in health care spending as a share of GDP. While much of the increase in consumption has been wasteful, in the sense of unneeded medical tests, it has not necessarily been frivolous. It is causing serious long-term economic problems.
Undergoing a Painful Process
We need to see personal income start to rise much faster, and ideally grow faster than the rate PCE is growing for the recovery to be long lasting and self sustaining. So far that has not been happening. Most of the increase in the savings rate we have seen since the start of the recession (and the savings rate almost always goes up in a recession) has come from spending falling faster than incomes, not incomes rising faster than spending.
Doing it that way is very painful, and runs the risk of a self-reinforcing melt down. If all of a sudden everyone starts shutting their wallets to increase their savings, then spending falls, which means lower demand and people becoming unemployed. When unemployed, your income is much lower than when you have a job. Thus you have less to spend, which means in turn more people lose their jobs. You wouldn’t go out to eat as much and thus waiters at the Olive Garden (part of Darden Restaurants [DRI]) would at first have lower tips, and then have a pink slip. That waiter would then go out to buy things at Big Lots (BIG) less often, and the workers there would lose their jobs, and they, in turn…
This is what is referred to as the paradox of thrift. If the savings rate can be increased by higher incomes, there is still a cost in that the growth rate of the economy (remember PCE is 71% of it) will not be as fast as if we spent each of those incremental dollars of income right away; it just means that a virtuous cycle is spinning less quickly than it might, rather than being locked into a vicious cycle.
Let’s face it: saving for a rainy day (or paying off debts incurred from previous parties) is less fun than having a party, both on an individual level and on a macro level. Economically, paying off debt is the same thing as savings, by the way.
The need to rebuild our savings rate is going to be a long-term drag on the growth rate of the country. For 30 years or so, since the savings rate started to fall in the early 1980’s, much of our economic growth has been artificially boosted by the falling savings rate, and that is true for both Republican and Democratic administrations.
The latest tick down in the savings rate will help boost growth in the first quarter, but it sets us back in solving the long-term problem and is simply another form of kicking the can down the road. First quarter GDP growth may well come in higher than expected, but it will be doing so at a cost.
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.
