Dunkelberg: Consumer Spending: 'Retro' or 'Party On?'

Unless you are a big company CEO or a Wall Street trader, you are fairly sure about what your income will be next year and ten years from now (including raises, inflation and all that). And, we should all be fairly clear on the fact that credit does not change our income, it only changes the time path of our consumption. If we borrow today, we must repay it “tomorrow” (Federal government excepted, of course).

So, what happened in the 2003 expansion?

It appears that large numbers of us ordinary folk began spending more and more of our current income around 1995 until at some point, our savings rate turned negative (we actually spent more than our after-tax earned income). Was this because we thought our future incomes would be a lot higher? For tens of thousands of consumers, this was probably the case, as many “ordinary” folk became real estate speculators, hoping to make a killing by flipping property before actually having to even settle on the purchase. We also felt that we were becoming “wealthier”. The stock market hit a new high and, after all, house prices never fall, right? And interest rates were historically low. Owners in California were cashing in on appreciation every year as their appraised home values rose. However, this did involve ever increasing debt payments, which should have slowed down spending gains a bit.

The Crisis: 1 Year Later - A CNBC Special Report - See Complete Coverage
The Crisis: 1 Year Later - A CNBC Special Report - See Complete Coverage

From 1995 until 2009, consumers spent on average 93.8% of their income.

Early in the period, consumers spent less than that, later in the period the spending rate was higher until the recession started in 2008. Viewing the use of credit as a device to pull future consumption into the current period, it is clear that after partying hard in the expansion, a period of increased frugality and leaner living has to follow, even if there were no recession (which has exacerbated these adjustments). For every extra dollar of spending we did in the expansion financed by borrowing, we must repay a dollar plus interest in future periods and live less extravagantly. That’s where we are today. Eventually, we may return to spending 93.8% of our incomes on average, but not until we have under-spent our incomes by roughly the same amount that we overspent. The 30 year average ratio of Consumption to Disposable Income is 90.4%. If consumers are retreating to the “good old days” with a double digit savings rate, we have quite an adjustment ahead of us.

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The lower the “new normal” rate of spending out of consumer disposable income, the larger the structural adjustment required. A longer term reduction in the spending rate will produce excess capacity in retailing and restaurants, problems with commercial real estate credit, and depressed levels of construction in the affected markets etc. What will the recovery be like? It’s mostly in the hands of consumers. A 90% “new normal” would be difficult indeed but would restore domestic saving and reduce our dependence on foreign savings to finance our investment spending.


William Dunkelberg is an Economic Strategist, Boenning & Scattergood and Chief Economist, National Federation of Independent Business.