It has long been our underlying thesis that the huge amount of household debt accumulated during the housing boom would inhibit consumer spending and economic growth for some time to come, and this is what has been happening over the last few years. The errors recently found in the famous Rogoff-Reinhart (RR) book do not change this view.
Simply put, household debt averaged 77% of disposable personal income (DPI) over the 61-year period since 1952. It crossed over the average line in 1985 and took a sharp upward turn in 2000, eventually peaking at 130% of DPI in 2007. Since that time, consumers have reduced their debt to a level that is now 105% of DPI, still significantly higher than in the past. The result has been a significant slowdown and tepid recovery in consumer spending growth, a process that is far from finished.
The role of household savings is a key element in analyzing both debt and spending. For 41 years between 1951 and 1992 household savings rates as a percent of disposable income were consistently between 7% and 11%. However, as income growth started to slow down, consumers increasingly maintained their old spending habits by going into more debt and reducing their savings rate. This reached an extreme during the prior decade, when the savings rate stayed below 2% from 2005 through 2007, while debt soared. We all know how that ended.
No matter what you hear from the politicians, the media and “the street”, keep in mind that the combination of the household debt, low savings rates and tepid increases in income has been the reason for the deep recession and subsequent below average growth, and will continue to be the reason why economic growth will likely be slow for some time to come.
In the last two years, between the 1st quarter of 2011 and the first quarter of 2013, real consumer spending has increased by a meager 3.8%----and this was accomplished on an increase of only 1.1% in real disposable income as households reduced their saving rate from 5.1% to 2.6%. It therefore should not have been a surprise that spending looked so weak in March, and it should be no surprise when spending remains subdued in the period ahead. With consumer spending accounting for about 70% of GDP, it is easy to see why this puts a damper on the rest of the economy, particularly in a time of fiscal drag. The Fed is undoubtedly well aware of the outlook as they continue their attempt to try and offset, at least in part, the major headwinds elsewhere in the economy.None of the above analysis depends on the Rogoff-Reinhart (RR) research, some of which was recently found to be erroneous. First, RR emphasizes mostly government rather than consumer debt. Second, they maintain that when the government debt-to-GDP ratio crosses 90%, economic growth slows down. The idea that there was some specific threshold of government debt-to-GDP that led to slower growth was probably not valid in the first place. In any event, we think that for the near-to-intermediate term, it is the still-high level of household debt that is the key drag on the economy.