Spending is out, saving is in. The trend not only has legs, it has depth and magnitude, as the personal income and spending report for November reminds. But at a time when prices are falling generally, the gap between spending in nominal terms (i.e., before adjusting for inflation) and real terms (after inflation) is growing. Ditto for personal income. Therein lie some of the critical opportunities and risks for 2009 and perhaps beyond.
Let’s start with the basics. U.S. disposable personal income dropped 0.2% last month in current dollar terms, the Bureau of Economic Analysis reported on Wednesday. That’s down from a slight 0.1% rise in October and the first monthly fall since July. A sign of the times, given the recession now in progress.
Troubling as the trend is, spending fell even more: personal consumption expenditures crumbled by a hefty 0.6% in November. That’s not as steep as October’s plunge in spending, as our chart below shows, but the general trend remains intact, namely: down. For obvious reasons, Joe Sixpack is no longer shy about avoiding trips to the mall.
All of that is in the familiar statistical terms of reporting in current dollars, which is to say before adjusting for inflation. As it happens, inflation is conspicuously absent in general terms these days, as we’ve been discussing. As a result, after converting spending and income into real terms (adjusting for inflation, or deflation, as is the case at the moment), the trend looks quite different compared to looking at the numbers through a current-dollar prism.
In real terms, disposable personal income rose—yes, rose—by 1.0% last month, which is in sharp contrast to the modest current-dollar decline. Meanwhile, personal consumption spending advanced by a robust 0.6% in November in real terms—a complete turnaround from the 0.6% loss in current dollar terms.
Why the huge difference? Deflation. It’s debatable if deflation will stick around for any length of time. Certainly the Fed is pulling out all the monetary stops to kill the deflationary trend. Similar efforts are underway on the fiscal front, with the incoming Obama administration planning to roll out a new round of government-sponsored stimulus to complement the former and current spending sprees. In terms of our chart above, it’s easy to get the black line to rise: printing more money and handing it out never falls to boost income, at least in nominal terms and in the short term. The great debate is how to find success on the far tougher chore of elevating the red line (spending).
As for the here and now, the general decline in prices is giving cash an embedded positive return in real terms. Today’s dollar is worth more tomorrow because goods and services are cheaper with each passing day. True, not every product or service is declining in price. The price of medical care, for instance, is still rising. But broadly speaking, prices are falling and that means that Joe Sixpack’s paycheck is rising in real terms even if it’s unchanged or declining slightly by current-dollar measures. Similarly, despite the nominal fall in consumer spending last month, real spending rose, thanks to deflation.
To some degree, the real increases in spending and income are technical adjustments that aren’t fully reflected in the everyday lives of people. But the deflationary winds aren’t just an accounting trick. A dollar buys more today than it did yesterday, and it’ll buy more tomorrow than it does today. Yes, that’s yet another channel of stimulus. Consumers can take advantage by consuming more without spending more. Or, they can repair/enhance household balance sheets because saving another dollar in nominal terms translates into an even higher rate of real savings.
But economic decisions, it seems, are a double-edged sword in extreme at the moment. Certainly there’s a bright side to deflation if you’re a consumer/saver. The dark side is that the trend threatens to inspire savings to the extent that non-essential spending and investing is delayed indefinitely. That’s a problem because while it’s great to be a consumer/saver when deflationary winds are blowing, it may be hard to keep/find a job if consumption takes an extended holiday.
True, given the past excess in consumption, a bout of savings is just what the doctor ordered. But when does the solution become a problem?
Alas, there’s no free lunch. There never is. The challenge here is that economic growth requires spending even as consumers need more savings. Something on the order of 70% of the American economy is powered by consumer spending. If nominal spending dries up because everyone’s waiting for cheaper prices, household balance sheets will enjoy some much-needed enhancement. In the short term, however, there may be a price to pay for that a new-found desire for thrift. Such are the risks if/when an economy tries to reverse a generation of excess consumption overnight. Depending on how this all unfolds, we may be headed for the dreaded deflationary trap in 2009: lower prices induce more savings, which fuels lower prices, which inspires more saving, etc., etc. It’s not fate, of course, but the risk is there.
Given the state of the economy at the moment, there’s a fine line between higher savings and promoting a deflationary trap. The U.S. may soon discover exactly where that line is drawn.