The December report on Personal Income and Spending showed that personal income rose by 0.4%, one tick higher than the expected 0.3% increase, but a slowdown from the 0.5% rate in November. The November rate was, however, revised up from 0.4%, so the December rate is flat from where we thought Personal Income growth was yesterday.
On the spending front, Personal Consumption Expenditures (PCE) rose by 0.2%, well below the 0.7% rate in November, and a tick below the 0.3% expected rate. The November rate was revised higher from the original 0.5%.
Savings Rate Rising
If income is rising faster than spending, it means that the savings rate is rising. In December it was 4.8%, up from 4.5% in November. In the long term, we need a higher savings rate, and the low savings rate over the last decade has been like a cancer eating away at the country’s economic health. Since we are not producing enough savings at home, we are forced to import them from abroad, mostly by going into hock with places like China and OPEC countries.
However, in the short term, a rising savings rate is a drag on economic growth. How to go from a very low savings rate to a high one without a rising savings rate is a bit of a mystery. The best of all economic worlds is to have a high but declining savings rate, but that is not the situation we are in today.
Clearly the best way is to have incomes and spending both rising but incomes rising faster than spending, which is what we saw in December (and not what we saw in November). The graph below (from http://www.calculatedriskblog.com/) shows the long-term history of the personal savings rate.
A few things leap out from the graph. The first is that the savings rate had been in pretty much of a secular decline from the early 1980’s until the start of the Great Recession in early 2008 when it fell below 1.0%. It has increased dramatically since then, although erratically, and was at 4.8% in December, up from 4.5% in November. It had spiked to 6.4% in May.
...And So is the Trade Deficit
The secular decline in the savings rate happened at the same time that Consumption was growing to be an ever larger part of our economy, and Investment had become a smaller share. It has also coincided with the growth of the trade deficit to which it is intimately linked. (See "The Changing Composition of GDP").
As a matter of accounting identity, a current account deficit (trade deficit) has to be matched dollar for dollar with a capital account surplus. If you buy something (say, import $300 billion or more in oil) and don’t pay for it fully (sell only $200 billion in grains) then you will end up owing $100 billion. Increasing debt is the same as reducing savings.
Another thing to notice from the graph is that the savings rate increases during recessions. While our savings rate now is much higher than it was just a few years ago, it is still only about half the rate that was considered normal back in the 1960’s and 1970’s. It is also well below what is normal for most other major economies.
The second graph shows the year over year change in both Disposable Personal Income (income after taxes) and in PCE going back to 1960. Unfortunately, as of this writing the St. Louis Fed had not updates the numbers yet on their website, so the graph is only through November, but when updated, both lines will be up a bit more. Also, both series are in nominal terms, so the high levels in the 1970’s on both sides are largely due to inflation.
When the red line in that graph is above the blue line, it means the savings rate is falling. What leaps off of that graph is that both personal income and PCE both actually turned negative year over year during the Great Recession, something that had never happened before, at least in the 50 years that the data has been available.
Lower PCE means that people are holding on to their wallets and not going out to shop at Wal-Mart ([url=http://www.zacks.com/stock/quote/wmt]WMT[/url]) or if they are, they are not spending as much. Part of the reason was that their ability to do so out of current income was crimped by less money coming in. However, part of it is a deliberate decision on the part of consumers to try to repair their damaged balance sheets by holding on to more of what they earn.
Mixed Results, but Net Positive
While I would like to see faster growth in both Income and spending, over the long term it is imperative that income rise more than spending, which is exactly what happened in December. The fact that both were lower than in November is a negative, but the upward revisions to November were a good thing to see (although I wish the income number was up more than the spending number in November). All in all, I would count this as a moderately positive report.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With
more than 25 years investment experience he has become a popular commentator
appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in
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