The Plug FactorAugust edition of: The Richebächer Letter.
At first look, the May consumer income and outlays numbers - which we were eagerly awaiting last month - appear excellent: Incomes are up 0.6%, and spending is up even a full percentage point. At second look, after adjustment for inflation, the reality is pretty ugly.
The increase in disposable income melts to less than 0.1% in real terms, and that of spending to 0.4%, of which well over half came from the burst in motor vehicle promotion. Spending on nondurable goods has been flat for two months. The whole of the extra increase accrued from a blip in spending on services.
Amazingly, this sharp slowdown in consumer spending, though lasting for half a year, has been met with flat denial all around. During the five months to May, it was up in real terms by $78 billion, or $186 billion annualized. This is less than half of the consumer spending growth in the second half of last year - $376 billion annualized. Meanwhile, we know that June was another horrible month for consumer spending.
One important reason for the general indifference to this drastic reversal in consumer spending was apparently the fabulous job figures for the three months March-May that the Bureau of Labor Statistics (BLS) miraculously pulled out of the hat, reporting almost 1 million new jobs during these three months.
It shocked us to see how readily and uncritically research institutions, economists and media around the world accepted these numbers at face value, even though they came like a bolt from the blue in the face of otherwise rather mixed economic data. For the few who wanted to see, these numbers were bluntly suspect.
It turned out that virtually two-thirds of the new jobs had come not from the survey, but from a new computer model. For decades, the BLS has aimed at small businesses when measuring job creation in times of recovery, especially those not captured by its established monthly survey. Until 2000, this statistical adjustment was fixed at 35,000 each month, called the "plug factor."
The recent sudden jump in these figures towards 300,000 each month results from a computer model based on a calculated "net birth/death adjustment," which is supposed to measure how many jobs small firms have created and shuttered. In this way, the former monthly 35,000 figure exploded into numbers that are almost 10 times greater.
For us, the sudden statistical spike in job creation during March-May was massively out of whack with prior numbers and other concurrent economic data to be credible. Then came June: 112,000 new jobs created, less than half the expected number. We never saw it mentioned that the net birth/death adjustment contributed 182,000 to this disappointing increase. Without it, employment would have fallen 70,000.
What all this means for the U.S. economy's prospects should be clear: The suddenly strong support from job and income growth looks very much like a mirage. To the contrary, sharply slower consumer spending is essentially exerting the opposite effect of depressing income growth.
What, then, induced the American consumer to his sudden retrenchment in spending in the first quarter? Partly due to lower taxes, his nominal disposable income grew during the quarter by $171.7 billion. Yet he raised his spending by only $119 billion, putting fully $52.7 billion of his higher earnings into savings. That was definitely a drastic break with his past spending mania.
The salient point here is that the retrenchment was plainly not forced by tight money or credit. Oddly, consumer borrowing set a new record at the same time with an increase by $1,008.2 billion at annual rate, after "only" $659.9 billion in the prior fourth quarter of 2003. We have a hard time making sense of this mixture of income growth, savings growth and record borrowing.
The answer probably lies largely in the fact that the "average" private household is a statistical fiction. The other day we read that nearly a quarter of households have to spend 40% of their current income on debt service, as against 14% on average. On the other hand, there are, of course, many households with net income from assets after debt service. Higher bond yields and loan rates speak, in any case, for sharply lower borrowing in the future.
In April, an increase in nominal disposable household income by $52.3 billion compared with an increase in their spending by a mere $16.3 billion. In real terms, spending even declined slightly. No less than $36 billion went into savings. Due to the huge promotions and rebates by the automakers, spending in May was drastically distorted. Purchases of durable goods were up $17.8 billion, accounting for 54% of the total increase. News about auto sales since then has been disastrous.
Glancing over the figures for real personal consumption expenditures, it strikes the eye that the sudden spending weakness has gripped all sectors of consumption, services and non-durable goods, as well as durable goods.
As mentioned earlier, lesser consumer spending essentially means lesser income growth. If allowed to develop, it implicitly turns into a vicious circle where lower and lower spending leads to lower and lower incomes. One has to wonder what Mr. Greenspan can come up with next. In 2001, he had more than 500 basis points of interest rate cuts at his disposal to fight the economy's downturn, led by plunging business investment.
Our view has always been clear and unambiguous. Ultra-cheap and loose money together with fiscal priming of unprecedented scale have provided a tremendous stimulus to consumer spending in the United States. For the bullish consensus, this policy stance has been most successful, as measured by recent real GDP growth of 4% and higher at annual rates.
For us, this is a much too simplistic and superficial a view. Lost in the celebrations are the long-term costs of this recovery as manifested in the form of ever-mounting structural imbalances - namely record trade gaps, record levels of financial leveraging, record levels of personal indebtedness, a record-high budget deficit and rock-bottom national savings.
For any reasonable person, it ought to be clear that this cannot be the road to healthy economic growth.