Why Consumer Spending Remains Below Normal


We are now into the eighth year of this economic expansion. The unemployment rate is at a 16-year low (4.3%), stocks are at all-time record highs, home prices have fully recovered in most areas and wages are finally starting to rise. The question is, why aren’t consumers spending more? Consumer spending accounts for apprx. 70% of GDP.

In addition, borrowing costs are still historically low — the 30-year mortgage rate is near 3.9%, and mortgage debt-service payments recently were just 4.4% of disposable income, the lowest in decades. The other question is, why aren’t Americans borrowing more at these low rates?

In light of the factors above, these ought to be boom times for American consumers. Yet real personal spending has grown by just over 2.5% over the last year, when it should have been growing at closer to 4% as it did in 2015.

Source: Barron’s, Bloomberg

Most economists are baffled as to what is holding back consumer spending, yet the answer is quite straightforward. As I pointed out in detail in my May 23 E-Letter, total household debt in the 1Q of this year swelled to an all-time record of $12.73 trillion, thus surpassing the previous record of $12.68 trillion that Americans owed at the height of the housing bubble in 2007.

Soaring student loan debt is another particularly big albatross. Thanks to ballooning tuition costs, student debt now makes up 11% of total household debt, versus 5% in 2008. This burden is increasingly borne by millions of parents who have borrowed to help pay for their children’s education.

A third of new student loans made in recent years are considered “subprime,” and 11% of student loans have gone 90 days or more without payment. Student debt may or may not be a ticking time bomb like subprime mortgages. It isn’t securitized and sold throughout the financial system quite like mortgage debt was, but its pervasive spread saps consumer spending.

The bottom line is that Americans have now borrowed more money than they had at the height of the credit bubble in 2007-08, just as the global financial system began to collapse. Some consider this another milestone in the long, but slow economic recovery; others say we should be worried once again. I fall into the latter camp.

Source: Barron’s, Federal Reserve Bank of New York

It is my view that many American consumers are holding off on spending more of their disposable income, and continue to pay off debt and rebuild savings. Not all, or even most, consumers fall into this camp. You can’t have household debt at a new record high if most consumers are paying off debt, saving more and spending less. But there are enough consumers spending less and saving more to make a meaningful difference.

Then there’s the issue of rising interest rates. While interest rates remain near historic lows, most Americans know this is likely to change. The Federal Reserve has already raised the key Fed Funds rate twice and is likely to do so another couple of times this year. It is widely expected that the policy committee will raise the Fed Funds rate again at the end of next week’s FOMC meeting which concludes on Wednesday. I’ll have more to say about that in my E-Letter next Tuesday.

It doesn’t help that bank loan growth is starting to slow. Is that due to the uncertain timing of President Trump’s tax cuts and regulatory reforms? Or just the natural exhaustion of economic growth that has been pulled forward in recent years, leaving little pent-up demand? Or are companies tapping the capital markets instead of banks? It is very likely due to all three.

For better or worse, our economy is increasingly dependent on debt, and it now requires more and more credit to produce the same level of economic growth. It’s telling that year-over-year growth in personal spending on goods routinely surpassed 11% during the economic expansions of the 1960s and 1970s.

But by the 1990s, that figure never got above 9%, and during the 2002-07 expansion it peaked at just 7.7%. In the current expansion, spending growth on goods got as high as 5.9% in early 2015, but most recently it was down to just 3.6%.

At the end of the day, growth in consumer spending remains well below its historical average. We may disagree over the reasons why, but our below-trend economy is likely to continue. There is still hope that President Trump will get his tax cuts this year, which might boost the economy next year, but that is far from certain.

In the meantime, we should expect more of the same.




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