In July, Personal Income rose 0.3%, up from a 0.2% rise in June, and matching a 0.3% in May. The increase was slightly below the consensus expectations of a 0.4% increase. Meanwhile, Personal Consumption Expenditures (PCE) were up 0.8%, significantly higher than the consensus expectation of a 0.5% rise. That is a big turnaround from the 0.1% drop in June (revised from a 0.2% decline) and the 0.1% increase in May.
Of course, if spending is rising faster than income, it means that the savings rate is going down. The savings rate fell to 5.0%, down from 5.5% in June and matching May. The savings rate is well above the dangerously low levels that prevailed from 2004 to 2008 (although the annual benchmark revisions just substantially revised up the savings rates for those years). The graph below shows the long-term history of the savings rate using a three month moving average (from this source).
Savings Rate and the Economy
Over the long run, a higher savings rate is good for the country, and is desperately needed as the savings rate has been in more or less a constant secular decline for the last 30 years. Without domestic savings, we have to borrow from abroad to invest in the economy.
Capital imports are the flip side of the trade deficit. If we sell less abroad than we buy, then we go into debt abroad. That is the same thing as importing capital. The chronically low savings rate has left the country trillions of dollars in debt to the rest of the world.
Note that in the 1960’s and 1970’s the savings rate was normally around 9 or 10%, and started a long secular decline after the 1982-’83 recession. Prior to the 1980’s the U.S was the world’s largest creditor nation by a large margin. Now we are by far the world’s largest debtor.
The fall in the savings rate, and the increase in our indebtedness to the rest of the world, is not a coincidence — it is a causal relationship. The extraordinarily low savings rates in the five or six years leading up to the Great Recession were a disaster for the country, even though it made things seem good at the time.
A falling savings rate can give a very powerful boost to the economy, but only as long as it continues to fall. A low savings rate undermines the long-term economic strength of a country. In effect, it is a country having a feast on its seed corn. We are paying the price for that now.
In the short run, on the other hand, a rising savings rate slows economic growth. If someone gets a raise but does not spend more, then that raise does not stimulate other economic activity. If the raise is not spent, then there is no increase in aggregate demand. It either increases future potential demand, or pays for demand that occurred in the past (i.e. debt is paid down).
On the other hand, if people are socking away less than they were for a rainy day, it increases current demand. If people go out to eat rather than stay at home, it means that there is more work for waiters and cooks. If you are saving more seed corn to plant next year, there is going to be less to eat today.
Will Savings Stabilize?
The question is, will the savings rate stabilize here? The desire of consumers to sit on their wallets and not spend increases in income is very understandable. The collapse of housing prices destroyed trillions of dollars of wealth. That wealth people had been planning on using to finance their retirements or put their kids through college.
Housing wealth is (or at least was when the country still had it) far more “democratic” than stock market wealth. Personal housing wealth does not form the basis for large plutocratic fortunes. It is the stuff of which modest middle class nest-eggs are made. Now that money has to be replenished the hard way, by spending less than you earn.
Note how the savings rate tends to rise during recessions. That might seem counter intuitive, since it is very hard to save when you are unemployed, but it really isn’t.
The very fact that more people decide to save is one of the reasons recessions are, well, recessionary. On an individual basis being thrifty is a good thing, and so is paying down your debt. However, if everyone decides to do it at the same time, it is a very bad thing. This is what Lord Keynes called “The Paradox of Thrift.” It is the rise (or fall) in the savings rate, not the level that causes the pain (pleasure).
We need more domestically formed capital, rather than relying on importing capital from abroad. Of course if we bought less from abroad, and more of our consumption was of things made here, we would also not have to borrow from abroad.
Debt Service Ability Improving
The rise in the savings rate during the Great Recession was very rapid, and was one of the key reasons the recession was so severe. We are still a long way from the sort of savings rate we had back in the 1960’s and 1970’s, but we are a lot closer than we were a few years ago. People are making progress on repairing their balance sheets, but the damaged caused by the financial meltdown of 2008 and the resulting Great Recession, was catastrophic.
The process is being undermined by the resumed decline in housing prices. That decline in wealth does not show up in the savings statistics, but savings have to compensate for it over the long term.
The progress that consumers have been making in shoring up their ability to meet their financial obligations can be seen in the graph below. The red line shows just debt service as a percent of disposable personal income, while the blue line is a broader measure that includes things like rent payments. This is an underappreciated sign that things are getting better and is setting the foundation for a more durable recovery.
The Income Statement of the “national household” is providing better coverage of interest (and similar) expenses. On the other hand, the decline in asset prices, especially housing, has left the balance sheet of the “national household” extremely leveraged. Of course that is an aggregate of all the households in the country, and does not apply to any individual household (unfortunately, this data is only through the end of the first quarter, but all indications are that it continued to decline in the second quarter).
Where is the Income Coming From?
The components of Personal Income are as important as is the total number. There the news starts to look much brighter than it was last month. In total, personal income rose by just $18.7 billion in June, up from a $27.7 billion rise in June (revised sharply higher from $18.7 billion). That is also above the increase of $34.7 billion rise in May. (seasonally adjusted annual rates, as are all the subsequent numbers on the components of personal income).
In June, total wages and salaries rose by $24.2 billion, way up from increases of $8.9 billion in June (revised from a decline of $2.9 billion) and $20.7 billion in May. Private sector wages rose by $24.3 billion, up from a decline of $8.9 billion in June (revised from a decline of $2.2 billion) and a $21.1 billion rise in May.
Wages in the goods producing sector rose by $3.7 billion in July, up from a $0.3 billion decrease in June (revised from a decline of $1.8 billion) and a $4.9 billion increase in May. Wages in the private service sector were up $20.5 billion versus an increase of $8.9 billion in June (revised form a $0.3 billion decrease) and a $16.2 billion rise in May.
Overall government wages have now fallen in two of the last three months, and are at the same level they were at in March. In July they edged down $0.1 billion, after being unchanged in June and down $0.4 billion in May. This is a fairly long-term trend; in the second quarter of this year, Government wages and salaries were actually $4.1 billion lower than in the second quarter of 2010. Keep in mind that these are nominal numbers, and inflation affects postal workers, teachers and firefighters just as much as it affects everyone else.
Private wages and salaries are the most important, and highest quality, form of personal income. Government wages have to be paid out of either taxes or government deficits. Government workers do, however, spend their money in the private sector, just like private sector workers do.
To keep the numbers in perspective, total private sector wages are 4.62x larger than total government wages. Since December, private sector wages have increased a total of $214.0 billion, while government wages have increased by just $3.6 billion, a ratio of 59.4x. Just where is all that “runaway government spending” we keep hearing about?
Small Business Income
Another important source of personal income is proprietors’ income. In other words, what the self-employed and small businesses were earning. That rose by $3.2 billion in July, up from a $0.9 billion rise in June (revised from a decline of 0.8 billion) and a $0.1 billion increase in May.
The acceleration is all from the non-farm side, but farm incomes have been persistently weak over the last four months, but that is after a spectacular rise last year. Farm proprietors’ income fell by $0.5 billion in July, but that was down from a decline of $0.9 billion in June and a $1.0 billion drop in May. Weather is not helping out, with massive floods in some parts of the country, and record droughts in other parts.
Non-farm proprietors income (what is normally thought of as small business income) rose by $3.7 million, up from a $1.9 billion rise in June (revised from a decline of $0.3 billion), and a $1.0 billion rise in May. In other words, what we normally think of as small business income saw a rebound as well as wages, and like wages, June was not quite the disaster that was originally reported.
Farm proprietors’ income is tiny relative to non-farm at just $65.9 billion versus $1.0433 trillion. Non-farm proprietors’ income actually peaked back in December of 2006 at $1.1129 trillion, so small business income is still 6.25% below peak levels. On they other hand, it bottomed out in May 2009 at $971.6 billion, so we are now 7.38% above the valley floor.
Passive Income
Rental income rose by $5.0 billion in July, more than reversing a $1.2 billion decline in June and a $1.4 billion drop in May. Capital income, or income from dividends and interest rose by $7.5 billion in June, a deceleration from the $10.5 billion rise in June, and down from a $11.2 billion rise in May.
This income is particularly important to retirees. It is also income that goes overwhelmingly to the wealthy. Interest income fell by $0.5 billion, down from increases of $5.4 billion in both June and May. In light of the extremely low interest-rate environment, the decline this month is not particularly surprising — the increases in the earlier month’s is.
Dividend income rose $8.0 billion, up from a $5.1 billion rise in June, and a $5.8 billion rise in May. Corporations are sitting on a lot of cash, and not investing it by hiring people or putting up new buildings. Often instead of letting it just pile up on their balance sheets, they are returning it to shareholders through higher dividends.
This source of income overwhelmingly goes to the very top of the income distribution. The top 1% now gets over 23% of all the income in the U.S. and that income is not coming just from high wages; it is in large part coming from dividends and interest income.
Transfer Payments
The final big component of personal income is government transfer payments. Like government salaries, this source of income has to come from either taxes or increased deficits, and so it is a less desirable source of personal income from the point of view of the economy as a whole.
However, it is still income that gets spent in the economy. Wal-Mart (WMT) really doesn’t care if the money spent in its stores is from the elderly using their Social Security checks or the dividends they get from their investments, or really if it is retirees shopping there or people still in their working years spending their wages there, or their unemployment benefits. Transfer payments rose this month by $2.2 billion, down from an increase of $7.6 billion in June (revised down from a $9.4 billion increase) and a $3.8 billion rise in May.
Among the more important parts of Transfer payment income are Social Security, where benefits rose by $3.1 billion, up from a $0.7 billion rise in June, after falling $1.7 billion in May. Unemployment benefits fell by $2.3 billion in June, mostly reversing a $.28 rise in June. That, however, was after a decline of $4.4 billion in May.
Income from unemployment benefits has dropped in seven of the last eight months and is down 14.2% since December. There are lots of people who have now exhausted even their extended (Federally paid) unemployment benefits. At the end of this year, extended benefits will end altogether, unless Congress decides to extend them. Given the recent budget deal, that looks extremely unlikely.
Thus, come January, we are going to see a massive decline in transfer income. This is income that goes almost entirely to those at the low end of the income distribution. Medicare and Medicaid payments are also counted in the transfer payments, even though that is not income you can spend at the store.
Over the long-term, though, the economy cannot simply grow through ever-increasing amounts of money being handed out by the government. Those payments are very useful in the short run to help hold up overall consumer spending when the economy has turned soft. In the long run, the economy needs income from wages and salaries, and from small businesses earning profits.
It is those earnings and profits that pay the taxes that support the transfer payments. It is then worth looking at personal income excluding transfer payments, as shown in the next graph. Since it is a long term graph, inflation plays a much bigger role over time, and the graph is based on real personal income rather than nominal (which the rest of the numbers in this post are based on).
Note that during most recessions (and the immediate aftermath) incomes excluding transfer payments flatten out, but do not fall significantly. The blue line (left scale) shows we have not yet surpassed the level of total personal income ex-transfer payments we were at before the Great Recession. The red line shows that the year-over-year decline in such income was by far the steepest in modern history during the Great Recession. We are only about halfway back.
Very Encouraging Report
Overall, I would have to rate this report as very encouraging. While the overall increase in Personal Income was slightly less than expected, we got some very nice upward revisions to the June numbers. Those June numbers were very scary when they came out, and it is a relief to see them revised away.
Furthermore, the quality of the income was very strong. Of the total $42.4 billion increase in Personal Income, 57.1% of it came from higher wages and salaries from the private sector, and only 5.2% of it came through higher government transfer payments, and most of those came from higher Social Security payments (more people retiring as the baby boomers hit that age).
Income from small businesses also accelerated nicely and accounted for 8.7% of the increase. Investors also have to heartened by the continuing strong increases in dividend income.
On the spending side, the report was even more encouraging, with spending rising by $88.4 billion, way up from a decline of $14.3 billion in June and from a $14.8 billion increase in May. The 0.8% decline was far below the consensus expectations of a 0.5% increase.
The consumer, which represents about 71% of the economy was simply missing in action in the second quarter, but looks like they were returning early in the third quarter. Spending on goods rose by $39.5 billion in June, reversing a $24.4 billion decline in June (revised from a decline of $19.8 billion), after falling $21.6 billion in May.
Spending on Durable goods rose by $21.8 billion, after declining for four straight months. That may reflect some easing of the supply chain disruptions from the Japanese disaster.
Spending on Non-Durable Goods also rebounded, rising by $17.7 billion. That, however, came after drops of $11.3 billion in June and $8.1 billion in May. Those declines could not really be blamed on supply-chain disruptions. Changes in gasoline prices are probably much more of the story there. Spending on services rose by $39.5 billion way up from a $10.2 billion rise in June and a $36.2 billion rise in May.
The report provides pretty convincing evidence that the economy is not in the process of falling back into a recession. The June report, before the revisions, was disastrous and was one of the first reports that suggested we might be. Those fears really knocked the market for a loop, and it now looks to me as if it is pricing in a recession.
If we avoid a recession, the market should rally nicely between now and the end of the year. While that would be a welcome outcome for investors, it is not as if we are looking at robust growth, just the avoidance of a new recession.
This is not the time to be tightening up on either monetary or fiscal policy. Unfortunately, it looks like the powers that be are intent on doing both. Fortunately, it looks like the cuts in the initial phase of the debt-ceiling deal are back-end loaded, so the effect on the rest of this year will not be too dramatic, but they will have more of a bite in 2012 and beyond. Washington DC seems determined to repeat the mistake of 1937.
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