The optimism among dollar supporters hinges on the hope that the economists at the Levy Economics Institute of Bard College (LEI) are mistaken. While it’s true that the U.S. economy experienced growth exceeding four percent last year, a recent paper from LEI suggests caution. It highlights that despite the growth, the future appears bleak, with the “critical choices” confronting consumers acting as a significant obstacle.
LEI summarizes its concerns as follows: consumers face an unmanageable dilemma. They can either increase their spending, which would require assuming significantly higher risks, or they can reduce their expenditures, potentially triggering a recession. Essentially, they are caught between a rock and a hard place.
With American consumers encumbered by an unprecedented level of debt, even attractive financing options may fail to prompt purchases of items such as personal computers, large-screen TVs, SUVs, or the long-dreamed-of summer home by the coast. LEI’s economists warn that if consumers continue accruing debt, the combination of escalating debt burdens and rising interest rates could lead to unsustainable debt-to-income ratios. This scenario would likely result in a surge of personal bankruptcies and drastic cuts in consumer spending.
We’ve heard similar predictions before, yet they have not materialized into reality. Should we maintain our current attitude of indifference, or is it time to start stockpiling supplies like gold and canned goods?
According to LEI, things may not be as dire as some fear; however, the outlook is hardly positive: “If households recognize that they cannot continue mortgaging their incomes to service debt, they will begin to reduce borrowing and may slow their current expenditures.” This trend seems to be the more probable of the two scenarios they present. Moreover, a new consensus among Washington officials and Wall Street advocates suggests a growing emphasis on increasing personal savings, in response to recent discussions led by Federal Reserve Chairman Alan Greenspan and other key leaders.
Will we soon be forced into fiscal responsibility due to necessity? Let’s hope that retail consumers, especially those at stores like Kmart, can weather this storm.
Evidence supporting LEI’s predictions may not be immediately observable. The decline of consumer spending, often embodied by the archetype Joe Sixpack, is a pessimistic view that has proven inaccurate through history. Yet, every day brings fresh evidence that challenges this assumption. Take, for instance, the recent report from the Bureau of Economic Analysis, which showed that personal income increased by $33.2 billion or 0.3 percent in February, with disposable personal income also rising by $29.6 billion, indicating that consumers are indeed spending what they earn.
Interestingly, consumers are spending more than they earn, which presents an obvious concern. However, this might not be a disaster immediately, as evidenced by the 4.9 percent rise in same-store retail sales in February reported by the International Council of Shopping Centers, based on data from 69 retailers and noted by Bloomberg News.
Consumers, if they resemble many fortunate individuals, receive an abundance of credit card offers, promising new credit lines regardless of one’s credit history. How can LEI maintain its intellectual stance if consumers continuously receive credit despite their existing debt burdens?
Yet, one month of spending patterns does not establish a trend; caution should be exercised with the latest statistics. However, when viewed through the lens of the past decade or two, the tendency of Americans to indulge in consumption becomes evident. Breaking this habitual cycle will not be an easy feat, especially with little to no effort from major financial institutions like the Fed, Visa, or MasterCard to curb excessive spending.
This does not rule out the possibility that consumers could change their habits, nor does it discount the idea that a move toward financial responsibility could, paradoxically, lead to a recession in the broader economy. However, the pressing question remains: when will this day of reckoning arrive, and under what circumstances?
Numerous theories abound, but for now, let’s stick with LEI’s insights: “Personal consumption spending, including household investments, surged ahead of personal income in December 2004, but its current pace is unsustainable and is likely to stabilize or decrease in 2005.”
This year poses significant concerns for consumer spending trends, as highlighted by LEI. What could precipitate a shift in this dynamic? That’s anyone’s guess. However, considering the prolonged period of consumer spending and the considerable debt amassed, it’s conceivable that the trend may persist longer than what cautiously optimistic economists anticipate.
When examining potential triggers for change in consumer behavior, energy prices, particularly gasoline, come into focus. But before jumping to conclusions, we must consider the financial impact of $2.00-per-gallon gas on consumers—it’s often less significant than one might think. In that context, Legg Mason provides a helpful statistical perspective:
Take into account that the average U.S. driver travels about 12,000 miles a year. With the average vehicle achieving approximately 18 miles per gallon, this translates to around 650 gallons of gas annually. At $2 a gallon, the average annual expenditure on gasoline is roughly $1,300. Since gasoline is considered an inelastic good—a necessity whose use remains constant despite price changes—a 10% increase to $2.20 per gallon would raise annual spending to $1,430. But how significant is this $130 difference? With the 2003 average per capita income in the U.S. at $31,500, this increase is less than half a percent. While shocking at first glance, the overall effect on the economy and consumers is minimal.
If the public isn’t alarmed by $2.20, one might wonder whether prices of $3, $4, or even $5 per gallon could induce a change. This notion might seem far-fetched, yet parts of Europe regularly experience such prices, independent of OPEC influences. Interestingly, consumption rates in Europe are lower than in the U.S. Some European governments have even chosen to elevate gas prices to serve economic agendas, often transcending what a free market would dictate.
As of now, no such measures are imminent in the U.S. But the potential for government action always exists, especially under the right—or wrong—conditions. To paraphrase John Huston’s character from Chinatown: “Most people never confront the reality that, at the right moment and in the right context, they’re capable of anything.”
Meanwhile, with Goldman Sachs frequently issuing optimistic forecasts predicting possible “super spikes” in crude oil prices reaching $105 per barrel, markets may soon be devoid of government intervention regarding energy prices. Today’s forecast has already contributed to rising oil prices above $55 a barrel after recent declines. Perhaps there remains a slim chance that the consumer will opt for a quieter evening at home with a book instead of a shopping spree. But then again, be careful what you wish for.