A US consumption conundrum | FT Alphaville

A US consumption conundrum

After this unrelentingly awful week in US economic news, we should probably refrain from passing along a chart that’s headlined “End of the American Dream”.

But here it is anyway, courtesy of Reuters analyst John Kemp:

Kemp includes Gas & Energy; Food & Beverages; and Clothing & Footwear as the three categories that add up to “basic items” here.

And if you look to the far right, what you’ll see is that after a long period in which the share of Americans’ budgets that went towards these items declined steadily, in 2002 that percentage started rising — and after a blip during the recession, it’s climbing yet again, indicating that this might be part of a longer-term secular trend.

Here’s Kemp with a few specs (our emphasis):

For most of the post-war period, declining real prices for clothing and especially food caused the relative amount spent on necessities to shrink. Spending on basic necessities other than shelter fell to a low of just 13.67 percent of all consumption expenditures in Q2 2002.

But since then spending on necessities has been on a rising trend, interrupted only briefly by the recession in 2008 and early 2009. In Q3 2008, spending had hit 15.6 percent. By Q1 2011 it was back to 15.0 percent and has almost certainly risen further in the last two months.

In the final quarter of 2005, American households started allocated a higher percentage of their consumption expenditure to food, clothing and fuel than they had five years earlier, the first time in over six decades. Since then, the percentage has continued to creep steadily higher.

These numbers don’t include housing, which Kemp concedes — but as Bloomberg recently explained, rents are actually rising. The shelter index component of the CPI, roughly 32 per cent of the index, has climbed about 1 per cent in the year through April.

That may not seem like much, but rents had been tumbling since the end of the recession before reversing into positive territory at the end of last year — and on a year-over-year basis have continued on an upward trajectory since, with 0.1 per cent monthly increases in each of the last four months:

Hard to say how much this particular item should trouble us. A few economists have noted that the rebound in rents is the result of a housing shortage, at least for some kinds of housing, because the construction slump went too far. We find that persuasive. But as for how much further rents will fuel inflation, Tim Duy makes the sensible point that higher rents will eventually lead to a supply-side response of more multi-family construction and thereby dampen future price rises.

But the real point here is that despite QE-depressed mortgage rates and the ongoing decline in house prices, rents aren’t falling and therefore they aren’t offsetting the rising expenditures in the other categories of “basic items”. It’s a double-whammy, really, as falling house prices also erode wealth and consumer confidence.

Now back to Kemp for another chart, which shows that the big culprit is obviously Gas & Energy, but it also matters that Food & Beverage as a share of consumption has stopped falling in the last decade:

Ominously, this time around the effects of rising fuel prices are not being cushioned by falling costs for food. The current shock resembles 1973-74 (when spending on both fuel and food rose sharply) more than 1979-82 (when food spending fell).

The comparison is worrying because some studies suggest it was rising non-fuel commodity prices, not oil, that accounted for the depth of the recession in the mid-1970s (“Systematic Monetary Policy and the Effects of Oil Price Shocks” Ben Bernanke and others, 1997).

The sheds more light to what has been a confusing consumption situation since the start of the year, and also on the current policymaking environment.

Kemp further notes the short-run price inelasticity of these basic items, meaning that:

If consumers try to maintain real purchases of energy, apparel and food in the face of steeply rising prices, saving and spending on other goods must fall commensurately, as Professor James Hamilton explains in his survey of “Historical Oil Shocks”.

Recall that it was consumption that was mostly responsible (though not entirely; exports and declining inventories chipped in) for the rebounding economy at the end of last year. And everyone recognised it. As things ostensibly improved in Q4, it was hoped that enough household deleveraging had taken place that Americans could keep paying down debt while still spending enough to keep the economy moving. The end of the Bush tax cuts — and the shock to household incomes that their terminus would have produced — was averted by last-minute political compromise, and some of the original Stimulus measures were further extended.

And so when economic growth slowed in the first quarter, economists believed much of the problem to be temporary. They blamed the Japanese earthquake and supply chain issues, turmoil in the Middle East and the worrying rise in commodity prices, nervousness over the Eurozone debt crisis, and bad weather.

But they could point to decent and improving employment reports, a resurgent manufacturing sector, anecdotal evidence coming from surveys and from the Fed, and strong corporate profits as signs that growth would pick up again in the second quarter.

Well, not anymore — and today’s horrible employment report is just the latest in a string of bad news.

What happened? One possibility is that the temporary shocks were more severe and longer-lasting than anyone expected. Maybe the supply chain disruptions from Japan’s earthquake were bigger than we thought. Maybe people remain spooked by the commodities price shock despite the recent pullback, or by the possibility for further problems in Europe.

But there is also the simple possibility, one not mutually exclusive to those just listed, that the economy has been softer than economists thought all along — including when it seemed to be improving at the end of 2010.

Recoveries following deep financial crises are historically plodding as it is. If Kemp is right (and we advise you not to bet against him lightly), then this recovery is also facing secular trends that were present before the crisis and are now reasserting themselves.

Nothing about any of this is certain. Cyclical recoveries can be uneven, and maybe this month’s employment report and the other indicators of the last couple of months only represent a blip. Maybe those temporary shocks really are responsible for the disappointing growth we’ve seen, and we just need to wait a bit longer before the economy regains its momentum. Maybe growth will come from somewhere unexpected, or from exports, or a surprising push to hire by businesses. But this is an over-optimistic view, and it’s just as probable that things get worse.

As for what can be done, well, it’s extremely unlikely that any help is forthcoming from fiscal policy. It’s now political silly season in the US. (Okay, it always is, but the silliness gets amplified during the run-up to elections.) Recent political battles have had more to do with the debt ceiling and medium-term deficits than economic growth, and it’s therefore more likely that, if anything, fiscal policy will turn “contractionary” before it does anything more to help.

The monetary policy side is a bit more complicated. Earlier this week, the WSJ’s ace Fed-watcher Jon Hilsenrath recalled what Bernanke said in his presser:

In an April news conference, Mr. Bernanke said the tradeoffs that would come with additional purchases were becoming unappealing. “It’s not clear we can get substantial improvements in [employment] without some additional inflation risk,” he said.

And before today’s jobs report, the overwhelming consensus of economists would have predicted little chance for more rounds of quantitative easing. That’s probably still the case. The inflationary environment is different from what it was last year, when outright deflation was in the realm of possibility. And although today’s jobs report was gruesome and long-term inflation expectations have been falling, it’s probably not enough for the Fed to reconsider (yet).

Again, all of this could change, and a few more months of bad news could well bring renewed calls for QE3. But for now, the most that can be expected is that the Fed not shrink its balance sheet as quickly as was anticipated even a month ago.

Both the Fed and politicians in Washington probably had hoped that once their policies gave the US economy enough momentum to stand its own, they could go back to other economic priorities. The Fed could again start managing the business cycle through “normal” monetary policy, and Washington could sort out its medium-term deficit problems.

This is not what they had in mind.

Related link:
The perplexing US consumer – FT Alphaville
Payrolls fail – FT Alphaville