Ezrati’s Economic Outlook: The Consumer Is Back

Recovery in household spending could be a mixed blessing.

Americans, it seems, are spending again. Since late 2011, measures of consumption show acceleration in virtually all categories, despite the recent rise in gasoline prices. In one sense, this is good news for the economy, as it will push the pace of overall growth and ultimately prompt more hiring, which, in itself, will reinforce spending growth. The stock market has welcomed the flow of news in just this light, rising on each new sign of freer consumer spending. But—and there always is a but—this new trend raises longer-term concerns. More liberal consumer spending can only take the economy so far. Because heightened levels of consumption will limit households’ ability to make needed improvements in their finances, any effort to boost outlays too far too fast would only threaten pinched finances, resulting in spending cutbacks at a later date, say 2014 or 2015, with all the recessionary influence that would impose on the general economy.

Up until the closing months of 2011, consumers spent with extreme caution. Because the severe recession of 2008-09 created an understandable aversion to spending and debt, households favored saving over spending. In 2010, for instance, they increased spending only 3.8% but raised their savings flow to 5.2% of their after-tax income, to $588 billion a year, a jump of 28% from 2009. A similar pattern prevailed for much of 2011. Some of this savings flow went to asset purchases. Much went to pay down overall household debt, which fell by about $370 billion from late 2009 through the third quarter of last year. Every major personal debt category declined, from mortgages and auto loans to consumer credit, home improvement debt and general bank loans.

Household balance sheets improved accordingly. Net worth rose 6% during this time. Though some of this improvement reflected market gains, debt reduction and other savings flows were at least as significant. Consumer finances remained, of course, a long way from where they were in the early 1990s, before the debt boom took off. Household assets stood at 5.1 times liabilities in September 2011, up from 5.0 in 2009, but nowhere near the 6.5 times maintained through the mid-1990s. Still, finances were clearly on the mend.

But this improving pattern ceased late last year. Since last September, consumer spending has outpaced income growth. The annualized amount set aside from income for debt repayment and savings shrank back down toward $350 billion, averaging only 3.7% of after-tax income. Consumer credit increased at a 7.4% annual rate between September and February, the most recent period for which data are available. Figures on overall household debt are only available through year-end 2011, but, for that last quarter of the year, they show an 11.2% annualized growth in debt outside mortgages. The ratio of assets to liabilities improved to 5.2 times during that last quarter of 2011, but entirely because the stock market did so well. Apart from that, household finances would have shown a modest deterioration. Given the data that do exist for the opening months of this year, the pattern of the fourth quarter seems to have persisted.

This change is not necessarily ominous. Hikes in consumer spending do boost the pace of economic growth and help put labor markets on the mend. And this new pattern is, after all, only six months old. Households could easily return to their former caution and their former efforts at balance-sheet improvement. But if consumers really have abandoned their concern about financial health, then it is only a matter of time before they again begin to feel the pinch of debt and have to pull back. Their efforts in 2010 and earlier in 2011 simply failed to build a sufficient cushion to allow a new return to debt now. That eventual spending pullback could conceivably cause another economic downturn. Even so, it would take a while before matters begin to unwind, probably not until 2014 at the earliest. Given both the uncertainty and the timing, it would be premature to adjust portfolios or business strategies now for such an eventuality. Nonetheless, matters warrant watching.



About the Author

Milton Ezrati

Milton Ezrati

Milton Ezrati is senior economist and market strategist for Lord Abbett & Co. and an affiliate of the Center for the Study of Human Capital and Economic Growth at the State University of New York at Buffalo. His latest book, Thirty Tomorrows, linking aging demographics and globalization, will appear next summer from Thomas Dunne Books of St. Martin’s Press. See more of his articles about the economy here.



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