Updated look at income and savings: in which I eat crow

The Bureau of Economic Analysis released their first view of May's economic activity yesterday and also revised their Jan-April numbers, too. Unfortunately, the update is not entirely consistent with the view I offered last week, and so I must revise my analysis (please pass the crow). Here's an updated view of the same chart I showed you last week, limited to just the more recent months:

Source: Bureau of Economic Analysis

If you'll recall, my take before was that, with consumers' buying power rising and their savings rates falling, consumption would accelerate and thus the fears of a slowdown in our recovery were unfounded. This was a contrarian view to what we've been hearing about job growth stalling and consumer sentiment souring. However, the updated data shows that while buying power is indeed picking up steam, so has the savings rate.

The rise in savings rate is consistent with several recent surveys that have suggested that consumers are less optimistic than they were a few months ago. My interpretation was that the surveys were less meaningful than the savings data, because money speaks louder than words (call it the Bobbi Fleckman principle). Still, the income gains don't reflect a basis for the relative pessimism. Even if you look at buying power on a per capita basis, things are clearly getting better:

Ok, so maybe the nice 3-month run we're on will later get revised down. Or maybe consumers take longer to acknowledge the improvements and they'll perk up over the summer. Or maybe the improvements are too mild to overshadow the b.s. you hear on the news. Who knows, but I do believe there is a slight disconnect between reality and our perception of it. Or maybe my perception of it. Pass the ketchup.

The stability of the recovery

First, let me apologize for being away for so long. Work got busy and then I was overwhelmed by an apartment hunt (still am, in fact). It occurs to me that if everyone were busy with work and buying real estate then I suppose I wouldn't need to be making a case for optimism, nor would anyone be reading it, but that's not quite where we are, are we?

If you follow economic news, then when you aren't deluged with hand-wringing over Europe, you're getting slammed with worries over the recent jobs numbers. My take on Europe's influence on our economy is essentially unchanged since I last posted about it, so I am going to focus on the jobs concern. Employers don't seem to be adding jobs at a pace necessary to put everyone back to work within a reasonable amount of time. But as disturbing as this is, it doesn't mean we're headed toward another recession. For one thing, jobs lag demand (employers don't hire extra help until they can't keep up with customer demand) and consumer demand growth is steady, if unspectacular. Meanwhile, improvements in consumer sentiment and buying power suggest that it's reasonable to expect demand growth to accelerate modestly going forward.

Ok, I know this chart is ridiculous, but bear with me.

The solid blue line is showing changes in the total disposable income of US consumers from January, 2007 through April, 2012. It has been adjusted for inflation, so it is a good measure of consumer buying power - as the line goes up, consumers are collectively able to buy more stuff than they were before, and as the line goes down either inflation is rising or income is declining, or some combination of the two is taking place.

The red dotted line represents the consumer savings rate, defined as the percentage of disposable income that isn't spent. There are different reasons why this can fluctuate over time, but one of them certainly is consumer sentiment. If you are pessimistic about your financial future, you are likely to try to save more, and the opposite is true - if you feel relatively secure, there is less of a sense of urgency to prepare for seemingly unlikely bad times. So, it's fairly intuitive to appreciate how consumer spending is a function of these two factors; meanwhile, a review of how they have fluctuated in recent years lends insight into our prospects. 


Consider the shaded period (1). This corresponds roughly with the last recession, and it's plain to see that not only was buying power lower at the end of the recession than it was at the beginning, but also the savings rate ends the recession higher. (By the way, if you're curious about that income spike in early 2008, that was Bush's emergency stimulus tax rebates he sent out. It's interesting to note that the savings rate spiked along with it, indicating that people chose to save the rebate rather than spend it, which is entirely consistent with how you would expect a pessimistic populace to behave.) These trends are precisely what we should expect to see: bad times were occasioned by - if not defined by - a drop in buying power, and we collectively responded by getting more conservative in our spending habits. Indeed, almost half of the drop in consumer spending during the recession can be attributed to the increased savings rate.

Now look at the second shaded period (2), basically representing the last two years, where we see the opposite happened. Buying power rose slowly but surely, and the savings rate dropped like a stone. This is likewise intuitive; as our situation improved, we loosened the purse strings. Analyzing the consumer spending gains during this period, it's interesting that fully 60% of the increased consumer spending over the last two years was due to brightening consumer sentiment as articulated in the drop in the savings rate.

What does all this mean going forward? One conclusion we can easily draw is that, now that the savings rate is more-or-less back down to pre-recession levels, each additional dollar of buying power will generate more consumer spending than it did previously. So, to the extent we base our expectations on recent history (as the so-called conventional wisdom often tends to do), we will underestimate the effect even modest increases in buying power will have on consumer demand and, eventually, on job growth.

blaming the banks

People are still pissed at the banks for screwing us all over and this anger is horribly misplaced. It's like blaming the bartender for your hangover, and it's disturbing to think we may be learning the wrong lessons from this whole economic debacle. Consider the chart below, which shows that in the decade leading up to the Great Recession, the average person's debt grew at a rate roughly twice as fast as their income:

It's pretty easy to see the connection between this debt run-up and the economic collapse, but did the banks force us to borrow beyond our means? Did the bartender force us to chug down those extra shots? Many states have laws that restrict bartenders from serving obviously drunk people, and likewise our financial system used to have reasonably effective safeguards against these kinds of excesses. But they were dismantled by anti-regulatory zealots in the 1980s, 1990s, and 2000s. Who kept voting these people into power?

Similarly, there is a widespread misunderstanding about why we bailed out the banks. Some people smell a conspiracy but this overlooks the simple truth that we did it to save ourselves. If the local nuclear power plant started overheating beyond the control of its managers, it would be a no-brainer to send in public safety resources to prevent a meltdown that could ruin the surrounding communities. It was a similar concern that motivated the bailout of the banks. Our financial power system is as potent as our electrical power system and should be regulated accordingly.

But while re-regulating the financial system deals with the proximate cause of imprudent banking practices, it misses entirely the ultimate cause of out of control consumer debt. Why were people borrowing so far beyond what they could afford? As I argue in my Jan. 4 post ("Dirty Money"), I believe it was due in part to the Reagan and Bush II tax cuts that disproportionately favored the wealthiest and increased income inequality. In his timely, if tragically under-appreciated,  2007 book "Falling Behind: How Inequality Harms the Middle Class", the great economist Bob Frank argues that a good deal of consumer spending is positional - that is, much of it is aimed at gaining a competitive advantage in the great Darwinian game that is life on earth. For example, only half of our children can have an above-average education, so a scenario where the wealthiest bid up homes in the best school districts forces everyone else to spend more so as not to fall behind.

Sure, bankers behaved badly, but any worse than the rest of us who backed this ideology with our political support? Besides, the bankers' behavior was entirely predictable - the fact that many of the regulations we dismantled were themselves antidotes to the Great Depression puts such moves squarely into the "fool me twice, shame on me" category. Bottom line: to scapegoat Wall Street is to deny our own culpability and the fact that the GOP is still peddling these so thoroughly discredited ideas and the magical thinking they require only highlights the importance of getting our facts straight. We've already paid a heavy price for our schooling, so let's make sure we learn the right lessons: progressive taxes and responsible regulation are cornerstones of our prosperity.

How much should we be worried about rising gasoline prices?

That the recovery has taken root is now a well-established story in the mainstream media, so I was going to move on to other subjects but the recent coverage of rising gasoline prices and its economic and political implications seemed to be nearing a hysterical pitch, so I thought I should look into it.

Simply put, there is no relationship between oil prices and economic growth. (Statistics nerds will appreciate that my regression analysis of quarterly changes in real GDP against oil prices from January, 1947 - January, 2012 showed a correlation of 0.08, R-squared 0.006, and a standard error almost exactly the same as GDP's standard deviation. Further, I was unable to find any 10-year period in that span that featured a discernible connection between the two.) This is due in part to the fact that the energy industry is a major contributor to our economy. Beyond that, and perhaps contrary to conventional wisdom, it could be argued at this point rising energy prices are beneficial to our aggregate economic growth because we are once again net exporters of petroleum products. And in the short run it's not hard to imagine that steeply rising gas prices would accelerate the process of people catching up on automobile purchases they had deferred during the downturn.

So what's the big deal? The issue the pundits are wringing their hands over (and just about anyone who's had to buy a tank of unleaded gas understands) is that higher oil prices can divert consumer spending away from the things people really value (e.g., food, shelter, entertainment). But how much? To get an idea, it's helpful to look at energy spending's place in our collective household budgets and how that's changed over time:

A couple of observations:

1. There is a distinct long-run downtrend of energy's role in our budgets. This is consistent with the notion that over time we've become more efficient energy consumers.

2. The two big deviations from the trendline relate to the two most significant periods of oil price volatility: roughly 1974-1986 and 1999-now. The 1974-1986 period pretty much follows the same contour as oil prices, indicating that the oil price changes didn't affect our energy consumption as much as it crowded out spending on other things. This is the kind of painful displacement that political pundits think could derail Obama's prospects.

But a closer look at what's been going on since 1999 reveals a different story:

The period begins at 4%, the lowest level on record, peaks at 7% in 2008 (when oil spiked to almost $140/barrel) and ends at about 5.5%, just above the 5.25% average for the period. While the line broadly tracks oil prices, the slope tends to be much more gradual. This is very different from what we saw during the oil price shock of the 1970's.

Consumers' budgets are clearly less sensitive to oil price swings than they used to be, and there several reasons, including our diversification of energy sources (natural gas recently became the #1 home heating fuel) and efficiency improvements to our transportation. But perhaps most significant is the simple fact that we don't drive as much as we used to:

This chart shows per capita miles driven in the US since 1970. It's easy to see that we've driven fewer miles on average since the 2004 peak, but it's also noteworthy that the rate of growth prior to then was declining, too. In the 1970s and 1980s, per capita driving was growing at a 2.4% average annual rate, but the rate shrank to less than half that in the 1990s and up until the 2004 peak (1.15%). I could only guess as to why, but it's reasonable to imagine that it's at least partially due to the proliferation of the internet - there is so much stuff we do online that our parents used to have to leave the house to do (banking, shopping, working, etc.).

All of this is just to say that fears that a spike in gas prices will sink either our economy or Obama's prospects are way overblown. There is no evidence that higher energy prices actually damage our economy, and while no driver likes to see higher gas prices, it's not as big a deal as it used to be.

Income update

I mentioned in my last post that it would be worthwhile to look out for the March 1 report on personal income earned in January. Below is an update of the chart from my last post, where the focus is on personal income associated with business payrolls (as opposed to personal income from government sources or investment earnings). There are 2 noteworthy developments:

     1. The Bureau of Economic Analysis revised upward their #'s for 3rd & 4th quarter 2011.

     2. January's gains were roughly on par with December's.

Taken together, this should make us more confident in the sustainability of our economic recovery. Steady gains to personal income earned from private payrolls is the healthiest enabler of growth in consumer spending, and consumer spending is what ultimately drives our economy.