The Recovery is Unsustainable
Joe El Rady
The statistics don’t lie, the economy has moved from recovery to expansion; however, even if the nightmare scenarios and black swans I have discussed in previous posts remain only lurkers on the horizon, more pedestrian headwinds will likely retard the economy’s escape velocity. During the first three quarters of 2010, GDP grew at a very slow rate, especially for a post-recession period. The fourth quarter changed all that. GDP grew by 3.2% due mostly due to a very strong increase in consumer spending. In fact, as the figures clearly show, growth in consumer spending accounted for almost 100 percent of the increase in GDP. As I tweeted at the time, however, the growth in consumer spending did not occur due to higher levels of employment or increasing real incomes; the growth occurred due to decreases in personal savings. Such growth will ultimately prove unsustainable.
As everyone knows by now, the great recession changed savings patterns in America. Household savings rose from less than 2 percent of after-tax incomes in 2007 to 6.3 percent in the spring of 2010. However, by December 2010, the savings rate fell to 5.3 percent. At the same time, real personal consumer spending grew strongly at a rate of 4.4 percent (with spending on consumer durables soaring by 21 percent). All of this coincided with the steep ascent of the stock market (15 percent between August and December of 2010). While it is never statistically easy to infer causation from correlation, the link between that stock market rise and the Federal Reserve’s actions is fairly strong. In fact, Chairman Bernanke’s entire rationale for QE2, as he announced at the annual Fed Conference in August of 2010, sought to compel bondholders to shift their wealth to equity holdings due to the falling yields caused by the Fed’s open market purchases of treasuries. As the Fed predicted, the rise in equities would induce consumer spending by creating a wealth effect.
First, no reason other than the Fed’s actions seems to exist for the rise in the stock market. Second, the magnitude of the relationship between the stock-market increase and consumer spending rise fits the data. Examine this: share ownership (including mutual funds) of American households totals approximately $17 trillion. Thus, a 15 percent increase in share prices raised household wealth by approximately $2.5 trillion. The empirical relationship between wealth and consumer spending provides a function that predicts four dollars of additional consumer spending for every additional $100 of wealth. Just performing the calculation, the increase in the stock market should have produced a $100 billion increase in consumer spending. That figure very closely (and pretty uncoincidentally) matches the decrease in household savings and the resulting increase in consumer spending. Since US households’ after-tax income totals $11.4 trillion, a one-percentage-point fall in the savings rate creates a decline of saving and a corresponding rise in consumer spending of $114 billion.
Excellent, so now we know why the economy has seemed so strong lately, at least in terms of growth from consumer spending. But what does this predict about future performance? Given that no other reason seems to exist for the stock market to continue rising at the rapid pace it showed in 2010, and that the Fed has scheduled to end its Quantitative Easing by mid-2011, it does not seem likely that the savings rate will continue to decline, meaning that the pace of consumer spending will not continue to rise. Added to these realities, home prices have been falling and will continue to fall in 2011; and, the labor market remains weak. Furthermore, artificial support by central bankers has created asset-price bubbles that may be perilously close to popping. All of this contributes to the unsustainability of the current situation.
Joe El Rady
The statistics don’t lie, the economy has moved from recovery to expansion; however, even if the nightmare scenarios and black swans I have discussed in previous posts remain only lurkers on the horizon, more pedestrian headwinds will likely retard the economy’s escape velocity. During the first three quarters of 2010, GDP grew at a very slow rate, especially for a post-recession period. The fourth quarter changed all that. GDP grew by 3.2% due mostly due to a very strong increase in consumer spending. In fact, as the figures clearly show, growth in consumer spending accounted for almost 100 percent of the increase in GDP. As I tweeted at the time, however, the growth in consumer spending did not occur due to higher levels of employment or increasing real incomes; the growth occurred due to decreases in personal savings. Such growth will ultimately prove unsustainable.
As everyone knows by now, the great recession changed savings patterns in America. Household savings rose from less than 2 percent of after-tax incomes in 2007 to 6.3 percent in the spring of 2010. However, by December 2010, the savings rate fell to 5.3 percent. At the same time, real personal consumer spending grew strongly at a rate of 4.4 percent (with spending on consumer durables soaring by 21 percent). All of this coincided with the steep ascent of the stock market (15 percent between August and December of 2010). While it is never statistically easy to infer causation from correlation, the link between that stock market rise and the Federal Reserve’s actions is fairly strong. In fact, Chairman Bernanke’s entire rationale for QE2, as he announced at the annual Fed Conference in August of 2010, sought to compel bondholders to shift their wealth to equity holdings due to the falling yields caused by the Fed’s open market purchases of treasuries. As the Fed predicted, the rise in equities would induce consumer spending by creating a wealth effect.
First, no reason other than the Fed’s actions seems to exist for the rise in the stock market. Second, the magnitude of the relationship between the stock-market increase and consumer spending rise fits the data. Examine this: share ownership (including mutual funds) of American households totals approximately $17 trillion. Thus, a 15 percent increase in share prices raised household wealth by approximately $2.5 trillion. The empirical relationship between wealth and consumer spending provides a function that predicts four dollars of additional consumer spending for every additional $100 of wealth. Just performing the calculation, the increase in the stock market should have produced a $100 billion increase in consumer spending. That figure very closely (and pretty uncoincidentally) matches the decrease in household savings and the resulting increase in consumer spending. Since US households’ after-tax income totals $11.4 trillion, a one-percentage-point fall in the savings rate creates a decline of saving and a corresponding rise in consumer spending of $114 billion.
Excellent, so now we know why the economy has seemed so strong lately, at least in terms of growth from consumer spending. But what does this predict about future performance? Given that no other reason seems to exist for the stock market to continue rising at the rapid pace it showed in 2010, and that the Fed has scheduled to end its Quantitative Easing by mid-2011, it does not seem likely that the savings rate will continue to decline, meaning that the pace of consumer spending will not continue to rise. Added to these realities, home prices have been falling and will continue to fall in 2011; and, the labor market remains weak. Furthermore, artificial support by central bankers has created asset-price bubbles that may be perilously close to popping. All of this contributes to the unsustainability of the current situation.
posted by Joe El Rady at
8:57 PM
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