Consumers are back in action, indulging in their favorite pastime: shopping. Not only are they purchasing goods, but they are also doing so at an increasing pace.
According to a recent report from the Commerce Department, retail sales rose by 1.1 percent in February, the highest jump since September and significantly above January’s modest gain of 0.2 percent. This surge comes despite a 2 percent hike in payroll taxes and increased taxes on the wealthy. Clearly, reduced paychecks haven’t dampened consumers’ eagerness to spend.
This uptick in consumer spending is expected to benefit the first quarter GDP, as consumer expenditures account for approximately 70 percent of the U.S. economy. However, is a GDP increase driven solely by heightened consumer spending genuinely beneficial?
If that spending is backed by savings and capital investments, then it is. Unfortunately, much of this consumer spending is now underpinned by rising consumer debt, which could have long-term repercussions for economic growth.
In essence, individuals are borrowing now to finance purchases they haven’t yet earned. This financial behavior suggests that tomorrow’s payments will detract from future spending, potentially slowing economic growth.
Rising Consumer Debt
The current surge in retail sales also serves as an indicator of climbing consumer debt, reflecting how quickly consumers are accumulating debt. If this trend continues, reminiscent of the events leading to the 2008 debt crisis, we could see widespread financial strain among consumers.
It appears households are striving to recreate past consumption habits. Recent Federal Reserve data reveals that U.S. households increased their borrowing at an annualized rate of $312 billion in the fourth quarter of 2012, marking the most significant rise since the forced deleveraging of the Great Recession.
Clearly, households are no longer in a phase of deleveraging; instead, they are actively leveraging. Furthermore, additional Federal Reserve statistics indicate that consumer debt continued to escalate at an annualized rate of 7 percent in January.
It seems that the lessons learned from the recession have been quickly forgotten, as consumers are acting as if the economic recovery has already arrived.
The Driving Forces Behind the Stock Market Surge
Recently, the Dow achieved a noteworthy milestone, rising for 10 consecutive trading sessions—something it hasn’t accomplished in over sixteen years.
The last similar 10-day increase occurred in November 1996, during which the Dow climbed from 6,023 to 6,348—a 5.4 percent rise. Although the Dow didn’t rise each day afterward, it still gained 2.7 percent over the subsequent 10 trading days. From March 1 to March 14, 2013, the Dow grew from 14,054 to 14,539, marking a 3.5 percent increase.
Overall, the stock market is performing exceptionally well, with the Dow up 10.7 percent year-to-date. Yet, there’s a sense that something is amiss. What could be driving this momentum?
A significant factor is the increased reliance on debt to finance stock purchases, commonly referred to as margin trading. This involves borrowing money from a brokerage to buy stocks. According to Steve Keen, author of *Debunking Economics*, the proportion of stocks acquired through margin is currently at 70 percent. This means that with $300,000, investors can borrow up to $1 million in stocks.
Keen argues that there’s a strong connection between variations in margin debt and stock prices. As margin debt accelerates, stock prices also rise. Should this correlation hold true, the current increases in stock market valuations are largely driven by speculative borrowing.
Moreover, Keen points out that current margin debt levels are strikingly similar to those seen in 2000 and 2007, both of which preceded significant market downturns and widespread margin calls.
In conclusion, while rising consumer spending might seem like a sign of economic recovery, it is essential to scrutinize the underlying factors, particularly rising consumer debt and speculative trading practices. Only time will reveal the true sustainability of this upward trend in the stock market.
Sincerely,
MN Gordon
for Economic Prism
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