It's the Consumer, stupid

There are a number of reasons to be concerned about the sustainability of the economic recovery both nationally and here in Massachusetts.  In particular, recent consumer sentiment and consumer behavior data are particularly troubling. 

Consumer behavior is important for a number of reasons, not the least of which is how dependent the national economy is on what the Bureau of Economic Analysis terms "personal consumption expenditures".  

How important is consumer spending to growth?  Well, the latest US Gross Domestic Product release estimates that consumer spending contributed +1.4 percent to national economic growth in the second quarter of 2010 (total growth was estimated to be +1.6 percent in that same quarter).   In other words, pretty damn important.

So, what are American consumers thinking and, perhaps more importantly, what does their recent behavior suggest our economic future holds?

I think there are at least three things worth paying attention to....all of which are troubling.


1) Consumer confidence appears to be weakening

Nationally, consumer confidence (as measured by the University of Michigan consumer sentiment survey) remains relatively weak by historical standards and the latest data indicate consumers are less optimistic about the future than they were a year ago.  Closer to home, the news is no better according to the latest MassInsight's Consumer Confidence Survey for Massachusetts. 

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 2) The "deleveraging of household balance sheets" continues

In an environment where home equity continues to decline,  unemployment is high and interest rates are low, it is not surprising that many households are consuming less, saving more and paying down their debts.  In the long run this is a good thing but it in the short run it reduces consumer spending and slows economic growth.

The caution of the American consumer is all the more understandable given the most recent Flow of Funds report released by the Federal Reserve.  As Calculated Risk points out, the data in the report indicate that, "household net worth is now off $12.3 Trillion from the peak in 2007, but up $4.7 trillion from the trough in Q1 2009."  This negative wealth effect is undoubtedly constraining consumption as well.

However, this may not be as healthy as it sounds.  According to a recent Wall Street Journal Analysis of these same data, most of the "deleveraging" appears to be the result of consumer defaults on mortgages and other consumer credit obligations rather than through the paying down of these debts.   The Journal estimates that of the $610 billion in outstanding consumer debt that has been shed in the past two years, a mere $22 billion has been paid off in the traditional way, with the balance being reduced through credit defaults.

Source: Wall Street Journal

Many of these households that have been forced or have chosen to default on their debts will now find themselves unable to access consumer credit at reasonable (or even unreasonable) terms.   Absent access to credit, it is hard to imagine these families making major purchases (purchasing a car or a home etc) anytime soon.

3) Small businesses are worried about the lack of demand for their goods and services

As the Congress debates whether to extend the Bush tax cuts or not, one keeps hearing about how important small businesses are to job growth and how we must be very careful not to allow changes in tax policy to discourage them from hiring.

While undoubtedly small businesses create the majority of the jobs in the US economy,  it does not appear that taxes represent the biggest concern for our small businesses.  According to the most recent National Federation of Small Business (NFIB) survey, small business confidence remains weak.

As a number of observers have pointed out (notably Catherine Rampell and Paul Krugman), 31 percent of small businesses surveyed by the NFIB identified poor sales as their biggest problem.

Source: New York Times

So consumers are spending less in part because of legitimate concerns about their financial futures and job security, while small businesses can't hire because of weak consumer spending.  

A nasty catch-22 to say the least and a real cause for concern going forward....