Consumer Spending Dips

Just when we were starting to feel better about the economy and were bringing out our forecasts of and end to the recession by the end of the year, consumers seem to have withdrawn again. That’s bad news, and if the March data is a sign of things to come our slump may last longer than I feared.

First a brief look at the data.

The thing that leaps out at me most is that practically all of the first quarter improvement in consumption, which was a major contributor to yesterday’s GDP announcement, came in January. Consumer spending jumped strongly back then, going up 0.9%, giving us all hope that the huge decline last year was ending. Since consumption is over two thirds of our economy this was heralded as good news and touted as one of Bernanke’s famous ‘green shoots’. Unfortunately the recovery ebbed quickly in February, which had a gain of only 0.1%, and then died totally in March where spending actually declined by 0.2%. So January is beginning to look like an aberration rather than the onset of a healthy new trend.

Other numbers in today’s release support that:

incomes have taken quite a big hit. This is not on a per capita basis, but in aggregate. Wages paid out fell $32.9 billion in March, after declining $28.8 billion in February. Obviously rising unemployment is beginning to bite. Overall personal incomes, a figure that includes other things apart from wages, fell even more. It declined $34.4 billion, or 0.3% in March.

This data suggests that the economy is still on life support. The GDP release yesterday showed that consumption grew in the first quarter: it contributed a positive 1.5% to the GDP figures and so prevented the reported decline of -6.1% from being even worse. That slight show of strength was one of the only bright spots amid the overall gloom. Now we find that all of the strength was in January and has already dissipated.

There is no interpretation I can give that spins this data as a ‘good thing’. We clearly remain stuck in a downward pattern, albeit not as precipitously as before, but downward nonetheless.

This places even more pressure on the administration’s efforts to kick start the economy, and heightens the urgency around all our efforts to get the auto and banking industries cleaned up. Meanwhile rising unemployment seems to be sapping the life out of consumption, so we should expect a very mixed bag of data over the next few months. Our hope for an end to the recession is even more firmly pinned to a recovery of business investment, especially inventories.

In this regard I want to issue a caution: I have been reading and hearing quite a bit from analysts [e.g. in the Wall Street Journal] that the emergence of inventories as the most likely engine of growth later this year makes the next few months appear to conform to a more typical economic cycle trajectory. Do not believe that for a moment. Were that the case the recession would have started as a result of companies cutting back production is response to an unanticipated build up in inventory. That’s just not true. This recession began in the financial sector not in manufacturing. History shows us that the recovery paths from financial system led downturns are both less sharp upwards, and much more difficult to negotiate. A re-stocking of inventories may well be the technical reason the recession ends later this year, but it will not be the driver of a sharp uptick in growth.

Inventory led business cycles are typically characterized by sharp “V” shaped recessions and recoveries with the economy getting back to its ‘normal’ growth path very quickly. They also are typified by sweeping lay-offs in manufacturing followed by equally large scale re-hiring a few months later.

This cycle will not follow that path.

There is simply too much debt and rotten asset garbage cluttering up the banking system for us to expect anything but a slow and steady recovery spread over a period of two or three years. It will take us that long to get back to those ‘normal’ growth levels. And even then we may have to reconsider what ‘normal’ is. After all the past three decades ‘normal’ growth was based upon a heavy diet debt. It was unbalanced.

Our most important economic objective over the next decade is to get our balance back. That means more savings, less debt, and steadier consumption.