Consumers Can't Go On Like This. Or Can They?by
Although the official numbers will not be available for another month, solid fourth-quarter economic growth of 4% or better is now generally taken for granted by policymakers, most economists, and the financial markets. The new question: Just how much will the economy slow down in the first quarter of 1994? The answer will have important consequences for Federal Reserve policy and interest rates.
The popular view right now is that consumers will have to take a breather, after a run of spending in the second half of 1993 that outstripped their incomes and drained their savings. Add in higher taxes and the recent surge in installment debt, and you have the makings of a consumer retrenchment that will drag down growth.
Or do you? Consumers may not need as much rest as you think. As yet, they show no sign of tiring. Retail sales rose 0.4% in November, following an upwardly revised 1.8% surge in October. Retail sales have now risen for eight consecutive months, driven by a pattern of strong demand for cars and housing-related goods. In particular, furniture stores reported a 3.7% surge in their receipts in November, the largest gain in more than 10 years.
In fact, while sales of furniture and appliances make up a mere 6% of total retail sales, they contributed about half of the overall November sales increase. And during the past six months, purchases of all durable goods have accounted for 70% of the growth in retail receipts.
So far in the fourth quarter, inflation-adjusted sales figures are rising even faster than they did in the third quarter (chart). The numbers thus far easily support the notion of 4% growth in real gross domestic product, with an increasing chance for 5%.
Judging by sales of cars and light trucks, consumers maintained their strong buying pace in December. Sales began the month at a 12.5 million annual rate--7.1 million for cars and 5.4 million for light trucks. That's only slightly below the 12.7 million pace for all of November, which was the best in almost three years.
Little wonder, then, that the makers of cars and trucks are the busiest in years. In November, a 12% jump in car output and a 6% jump in truck production led a steep 0.9% advance in industrial production, the sixth consecutive increase. In addition to cars, ether consumer durables, business equipment, and materials posted big gains.
In manufacturing alone, output rose 1%, continuing a pattern of acceleration in recent months (chart). Vehicle output accounted for about half of the November gain. Manufacturing production is on track to post its largest quarterly advance in 6 1/2 years.
Will this momentum subside in the first quarter? Not if consumers have their way. A close look at incomes, savings, and borrowing suggests that households have the wherewithal to keep spending.
To begin with, income growth remains sturdy. Flood and drought losses clobbered farm income during the third quarter, but the other 99% of real personal income was up at a 3.3% pace. That's not far below the 4.4% gain in real consumer spending. In fact, from March to October, inflation-adjusted consumer outlays rose at an annual rate of 5.4%, while nonfarm income increased at the same pace. So where's the income problem?
Starting the fourth quarter, October real income stood some 2.5% above its third-quarter level, at an annual rate. And judging by strong November growth in employment and weekly earnings, combined with low inflation, higher income in that month pushed up the quarterly growth rate even more.
The argument that households are draining their savings is also flawed. During the past six months, the personal saving rate has fallen from 4.9% to 3.7%. That has more to do, however, with the way the Commerce Dept. measures savings than with reality.
The problem is that consumer spending in recent months has been concentrated in big-ticket durable goods, such as cars, furniture, and appliances. Although these items are usually financed, Commerce includes the full price of the goods in its measure of spending. That causes spending to be overstated relative to income.
What muddies the water is that Commerce simply imputes savings by subtracting spending from income. So during periods of heavy outlays for high-priced goods, less income appears to be left over after spending. So savings tend to be understated. In fact, the boom in mutual funds and other financial assets suggests that households' nest eggs are much plumper.
Moreover, the sharp increase in consumer borrowing does not mean that households are throwing caution to the winds. Stronger job growth, benefits from mortgage refinancings, and rising confidence are behind the decision to take on more debt.
Most recently, coming on the heels of the big November gain in the Conference Board's index of consumer confidence, the University of Michigan's index of consumer sentiment showed a sizable rise for early December as well--to 87.7, from 81.2 in November.
From July to October, consumers added more dhan $19 billion to their installment debt--the most in any three-month period since the borrowing heyday of the mid-1980s. The three-month average of the ratio of debt to aftertax income, however, is no higher than it was a year ago. Borrowing, while accelerating, is not outstripping income growth.
Consumers' increased use of plastic is one reason the holiday sales look bright. According to MasterCard, store authorizations for credit purchases since Thanksgiving have soared nearly 21%, compared with the same period last year. MasterCard's data run through Dec. 10.
Another support for consumers: Low inflation continues to stretch the buying power of their incomes. The good news for 1994 is that inflation is not likely to accelerate from its 1993 pace.
The consumer price index rose a mild 0.2% in November--0.3% excluding food and energy. Annual consumer inflation through November is 2.7%, and the rate for all of 1993 will end up even lower. Falling oil prices will likely leave December's CPI unchanged from November.
Most of the progress against inflation in 1993 has come in goods prices (chart). Excluding the volatility caused by swings in energy and food prices, annual goods inflation in November was running at a mere 1.6%, with service inflation at 3.7%. Service inflation is probably headed downhill in 1994. In particular, just the threat of cost containment has already pushed medical inflation down to 5.5%--the lowest annual pace in two decades.
Low inflation is also making it easier for businesses to manage their inventories, since purchasers need to worry less about unanticipated price shocks. Business inventories were unchanged in Mctober, and they are at a 10-year low in relation to sales, which rose 0.4% (chart). Lean stock levels are a good sign that production will keep on moving up during the first quarter. Better inventory control also reduces costs.
Moreover, pressure on goods prices is likely to remain muted. Industry's rate of capacity utilization rose from 82.4% in October to 83% in November. That reading was the highest in more than four years and is close to the mid-80% reading associated in the past with production bottlenecks and price pressures.
But a steady stream of cheaper imports and excess capacity abroad will keep prices of domestically made goods in check. And because of impressive productivity gains, factory unit labor costs are falling.
With everything going their way, consumers are likely to continue to pull their own weight in early 1994. If so, any slowdown in growth will be limited. And unlike the economy's swoon in early 1993, the new year is set to get off to a good start.