Consumers Won’t Save the Economy: Economists
Consumer spending, once the driving force of the U.S. economy, is likely to remain stagnant for years as households face declining incomes, struggle to cut debt and build up savings, economists say.
According to a recent study from the BlackRock Investment Institute, the ratio of household debt to personal income (wages and salaries only) remains at a staggering 154 percent, which is only 7.5 percentage points lower than in pre-recession peak.
“While some progress in consumer debt reduction has been made, the heavy lifting of meaningful deleveraging still lies ahead,” says the study.
Until consumers repair their balance sheets, they are unlikely to increase spending and to take on any new debt even with interest rates close to zero percent.
That could continue to hamper the recovery since consumer demand makes up more than 70 percent of the U.S. economy.
The latest data from the Commerce Department shows that the already weak consumer spending grew in August at a meager 0.2 percent.Personal income declined 0.1 percent for the first time in nearly two years.
According to a separate report from the Labor Department, consumer spending fell 2 percent last year, following a 2.8 percent decline in 2009.
Persistently high unemployment, stagnant wages, high commodity prices and overall stock market volatility are slowing down the deleveraging process.
Many economists say the U.S. faces some similar risks as Japan during its so-called “lost decades.” Japan's economic crisis of the 1990s, caused by the bursting of a nationwide asset bubble, was followed by massive consumer deleveraging and lackluster spending in the 2000s.
“Private sector continues, just as in Japan, to desire a lower level of debt,” says Scott Mather, head of global bond portfolio management at Pimco.
On a positive note, he expects deleveraging of private sector in the United States to happen faster than in Japan, where it lasted 15 years. “Our real estate bubble was not as big as Japan’s, and we don’t have deflation expectations embedded in the economy,” Mather told CNBC.
But until households clean up their finances, Mather anticipates the economic growth to be no more than 0 to 1 percent.
Homeowners, who are underwater on their mortgages, have an even harder time resolving their debt levels. Some economists see home prices falling even further.
To fully unwind the bubble, home prices need to fall another 20 percent, says Joshua Shapiro, chief economist at MFR Securities. “As home prices decline further, there will be continued impetus for household deleveraging in order to offset the effect of lower home prices and probably lower equity values on balance sheets,” he says.
Some experts argue that the government needs to help speed up the delevering process.
“The key is to reduce the debt problem. Banks need to be induced to write down the principles on mortgages and give households debt relief so they can resume spending,” says Stijn van Nieuwerburgh, associate professor of finance at NYU Stern Business School.
A number of economists advocate more stimulus spending to keep economic activity from falling, so that households have revenue to repair their balance sheets.
But Mather says more government spending could potentially be counterproductive. “As government takes on more debt, consumers may start saving even more as they anticipate higher taxes ahead.”
“Evidence, including Japan, suggest that the private sector confidence is diminished from government spending when debt and deficits are already very high,” adds Mather.
Shapiro agrees that more government spending would accomplish nothing at this stage. “Government needs to allow delevering to occur, and not stand in the way of inevitable,” he says.
In fact, Shapiro believes that government needs to cut its spending and debt, curtailing social benefits and creating the need for more savings on the part of the households.
According to Shapiro, this necessary reduction in standard of living could create unrest, as seen in Europe. “This is going to be a long, painful process, with a real threat of social, political and economic upheaval.”
Both Shapiro and Mather want the government to focus on long-term structural changes to the economy, not short-term fixes.
“Fiscal spending needs redirection away from consumption and into investment in growth that raises U.S. competitiveness while producing jobs,” says Mather.
Shapiro agrees but is skeptical of Washington’s ability to deliver. “Long-term solutions and a short political cycle don’t mix very well,” he says.
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