Consumer spending jumped at the start of the year, as US households continued to demonstrate a willingness to spend more than their income, while the Federal Reserve's preferred inflation measure was well-behaved.
Personal spending rose 0.9 per cent in January, compared with a 0.7 per cent increase in personal income, the Commerce Department reported. The rise in spending was slightly below the consensus forecast while the income gain was slightly above.
But the savings rate dropped to minus 0.7 per cent from minus 0.4 per cent in December. Economists expect that declining energy prices, income growth as the labor market tightens and a slowing housing market will all encourage the savings rate to improve.
Economists define savings as the money left over after a person buys all their stuff for a specific time period. Therefore, for yet another month, Americans spent more than they made. The personal savings rate turned negative in the second quarter of 2005 and has been in negative territory ever since.
There are several reasons why people should find these figures alarming.
Consumer spending represents about 70% of US GDP growth. Therefore, the consumer's health should be very important for economists because an unhealthy consumer means slower overall US growth. A long trend of spending more than you make is very unhealthy. At some point the simple reality of the situation will weigh in on consumers and they will slow their spending, which will in turn slow economic growth.
Lack of savings means the consumer is ill-equipped to deal with economic downturns. Suppose a consumer who has regularly spent more than he makes loses his job. What will that person now use to support himself while he looks for another job? In theory he will use his savings. However, the evidence is the consumer doesn't have much in the way of savings, meaning an economic downturn could become and economic disaster very quickly.
Where is this extra money coming from? If a person spends more than he makes, the extra money must come from somewhere. The reality is the extra money is coming from using debt to purchase goods. As recently noted by Merrill Lynch Economist David Rosenberg (PDF) the US Debt to income ratio rose as much in the last 5 years as it did in the previous 15 years and currently stands at 126% of income. In other words, the US consumer is already leveraged to the hilt. As the Fed continues to raise interest rates, this ratio will start to crimp consumer spending as consumers look at their total debt levels.
The RWNM has attempted to bury this issue using a variety of tactics, none of which is intellectually honest.
The first is to use the record household net worth as a substitute for savings. This argument confuses asset acquisition - which requires present expenditures - with savings - which is the delaying of purchases. In addition, household net worth increased 100% under Clinton (from 21 trillion to 41 trillion) and 25% (from 41 trillion to 51 trillion) under Bush.
The RWNM has also pointed to the total amount of assets in US deposit institutions, which currently total about 5.7 trillion. However, when you divide this number by the total US population, you get about $19,000/person. This division assumes that all assets in the US are evenly distributed. Considering the more and more extreme stratification of wealth in the US, this seems highly unlikely. It is far more likely that the top 10-20% own a large percentage of these total deposits.
Finally, the RWNM attempts to use retirement assets in their savings' calculations. First, retirement assets are heavily taxed on early withdrawal, making them less than advantageous savings vehicles for pre-retirement access. However, even using the largest percentage contribution to a retirement account as a percentage of GDP, the largest contribution was to individual IRAs totaling about 3% of GDP in 2002-2004 period. This is not a large amount of money to set aside in the grand scale of things.
The bottom line is US consumers have not saved for the proverbial rainy day. Instead, they are spending as though money grows on trees. At some time, this trend must end. The only questions is when.
Link