The Return of the US Consumer

The following post is the second in my "United States of Debt" series that analyzes how the different sectors of the US economy will handle their high debt loads. The first installment can be found here.

During the housing bubble, American consumers loaded up on debt. Since the bursting of the bubble, Americans have adjusted by increasing their savings and paying down debt. This adjustment resulted in a slight decrease in consumer spending and a large decrease in residential investment. My analysis shows that the bulk of the adjustment in consumer spending is complete. The level of personal savings is driven by household net worth. As a percent of GDP, both household net worth and savings have returned to normal levels. Therefore if asset values can remain elevated, consumer spending can at least keep pace with normal levels of GDP growth for the foreseeable future.

As has been discussed previously in the Dynamist, a big secular trend over the past forty years has been the rise in consumer spending and residential investment as a percent of GDP.

Figure 1


As has also been discussed previously (namely here), virtually all of the long term increase in consumer spending can be attributed to the rise in (mostly non-voluntary) medical expenses and housing investment. Virtually all of the decline in household spending as a percent of GDP since 2005 can be attributed to the decline in residential investment from 6% of GDP to less than 2.5% of GDP.

Not surprisingly, consumer indebtedness climbed to support the increase in spending (particularly since personal income has not risen as a percent of GDP…to be discussed in a later post).

Figure 2


Also not surprisingly, the amount of consumer debt has started to decline with residential investment, albeit with a lag.

The increase in consumer debt shown in Figure 2 seems kind of scary until you compare that consumer debt with the amount of consumer assets.

Figure 3


From 1994 to 2005, household assets as a percent of GDP rose from under 425% of GDP to over 550%. With asset values surging, household net worth (assets minus liabilities) also surged, even with the large increase in liabilities. Figure 4 below illustrates the effects of the twin bubbles in stocks (in the 1990s) and real estate (in the 2000s) on household assets.

Figure 4


Looking at Figure 3, it appears that the preferred level of household net worth is about 350% of GDP, although it would make sense for this number to rise somewhat over the next decade as the baby boomers prepare for retirement. If we look at the long term levels of personal savings in Figure 5 and compare it to the long term levels of net worth in Figure 3, a pattern emerges.

Figure 5


When household net worth is around its long term trend of 350%, personal savings averages 4-6% of GDP. In the high inflation, high interest rate 1970s, when asset values were depressed, net worth dipped down toward 300% of GDP and savings rose above 6%. During the asset bubbles of the late 1990s and early 2000s, net worth rose well above 350% of GDP and savings fell below 4%. After the housing bubble burst, net worth fell back to 350% and savings promptly popped to above 4% of GDP.

Now that savings is at a normal level, consumer spending has the ability to keep pace with GDP growth. That does not mean that consumers won't choose to keep increasing their saving rates over the next decade, particularly the baby boomers as they prepare for retirement. As long as the savings rate as a percent of GDP exceeds the nominal growth rate of GDP, consumer indebtedness as a percent of GDP will decline.

Thus we see the importance of keeping interest rates low and preventing asset deflation. Financial assets like stocks and bonds fall in value when interest rates spike. Assets geared to inflation like stocks and real estate fall when you have deflation. The Fed will see propping up asset values to prevent another major spike in the consumer savings rate as a high priority for the foreseeable future. A spike in the savings rate would reduce final demand, which in turn would force the federal government to spend more money to prop up demand.