American Vitality Turns on Who’s Right, Harvard or Yale: EconomyJeanna Smialek
The American consumer’s readiness to kick the economy into high gear comes down to a question of who’s right: Yale’s Stephen Roach or Harvard’s Martin Feldstein.
To Roach, Americans are still working to rebuild savings and will be slow to increase spending as long as wage growth is sluggish and household debt exceeds long-run averages. “We have a long, long way to go,” says Roach, 68, a senior fellow at Yale University’s Jackson Institute of Global Affairs in New Haven, Connecticut, and former chairman for Morgan Stanley Asia.
Over at Harvard University in Cambridge, Massachusetts, Feldstein, 74, predicts “we finally are going to see a good year in 2014,” thanks to stock-market and home-price gains that have boosted household wealth and given consumers the confidence to spend.
Which view proves true will have a lot to do with whether consumer spending, which constitutes about 70 percent of the U.S. economy, makes this the break-out year for the expansion. Consumption gained momentum in 2013, and more vigor this year could spur still-hesitant businesses to hire and invest, augmenting growth.
“After saying year after year that the Fed and others have been too optimistic,” Feldstein says he thinks this year will be different. The former economic adviser to President Ronald Reagan and former chairman of the Council of Economic Advisers commented in a Jan. 13 Bloomberg television interview.
Feldstein has more economists on his side, a Bloomberg survey this month shows. Consumer spending will grow 2.6 percent this year and 2.8 percent in 2015 following a projected 2 percent gain last year, according to the median forecast of economists in the survey. That would make 2014 and 2015 the strongest years since 2006.
Feldstein and those who agree with him, including Goldman Sachs Group Inc. Chief Economist Jan Hatzius, cite gains in household net worth, which stood at $77.3 trillion on Sept. 30, $8.2 trillion more than its pre-recession peak. Wealth fell almost 20 percent during the recession that started in December 2007, and didn’t recover the lost ground until the third quarter of 2012.
Contributing to the gains: The Standard and Poor’s 500 Index last year posted its biggest annual advance since 1997. Home prices in 20 U.S. cities climbed 13.6 percent in October 2013 from a year earlier, the biggest increase in more than seven years, S&P/Case-Shiller data show.
Meanwhile, household debt loads have eased as Americans shied away from borrowing and banks hesitated to lend in the wake of the financial crisis. Revolving consumer-credit, primarily credit-card debt, plummeted 18 percent from 2008 to 2011, and had recovered just 2.6 percent through November 2013. Outstanding home mortgage debt remains below its 2008 peak. The deleveraging has left consumers with room to borrow.
“The main reason we’ve become more optimistic is that the household balance sheet looks much healthier,” Michelle Meyer, a senior U.S. economist at Bank of America Merrill Lynch in New York, said in an interview. “Consumers should continue to heal and feel ever more comfortable and confident in spending.”
Non-revolving credit is already rallying as Americans take out loans to buy cars and other big-ticket items, increasing by $11.9 billion in November after a $13.9 billion gain the month before, data from the Federal Reserve showed.
Goldman economists see an even “more important swing factor” taking shape in 2014: Consumers have adjusted to the hit to incomes from last year’s increase in payroll and income taxes, which won’t be repeated this year. That could help boost consumption growth to 2.9 percent in 2014, from their estimate of 2 percent in 2013.
Payroll and income tax increases last year held the growth rate for real disposable income to 1 percent, Hatzius, 45, wrote in the Dec. 27 analysis, and shaved 0.75 percentage point from consumption growth. This year, income growth should accelerate to 3 percent, boosting purchases and GDP, the New York-based economist said.
“The drag seems to have dissipated at this point,” said Peter D’Antonio, an economist at Citigroup Global Markets Inc. in New York. “The fundamentals of the consumer sector are going to show through in a big way.”
Gross domestic product climbed at a 4.1 percent annualized rate in the third quarter of 2013, boosted by consumer purchases that increased 2 percent, according to a Dec. 20 Commerce Department report. GDP growth was up from a 2.5 percent rate in the second quarter and 1.1 percent in the first. Fourth-quarter data come out Jan. 30.
Adding fuel to consumption, Feldstein said consumers who have rebuilt their net worth will be willing to spend more of their discretionary income.
The personal saving rate averaged 4.5 percent last year through November, down from 5.3 percent in the same period a year earlier. The saving rate is still up from a record-low 2 percent reached in July 2005.
“Last year, the consumer by reducing the savings rate boosted GDP,” Feldstein said in the television interview. “We’re going to see more of that as a result of this big increase in wealth that occurred though the stock market.”
Goldman Sachs economists wrote in a Dec. 27 note to clients that “the saving rate can fall a bit further as household wealth is increasing, credit conditions are easing, and the labor market is improving.”
Roach isn’t buying it. Savings will rise closer to historical levels and that will keep a lid on spending, he says. The saving rate averaged about 9 percent between 1970 and 2000.
“We’ve got several more years of surprisingly anemic consumption growth,” Roach said in an interview, predicting “at least two to three years” of 2 percent advances in consumer spending. “The path is well short of 3 1/4 percent norms we’ve become used to historically in the United States.”
Job market healing could help. Though a Jan. 10 report showed employers added 74,000 jobs in December, the smallest gain since January 2011, that was at odds with better gains throughout the year. Employment increased by 2.19 million positions in 2013, averaging more than 180,000 jobs a month.
Still, that’s little changed from 2012, and it’s shy of the sustained 250,000 readings Roach says would boost his economic outlook.
Plus, the portion of prime working-age adults in the labor force dropped to 62.8 percent in December from 65.8 percent five years before. Some 3.9 million Americans have been out of work for more than 27 weeks, and Congress hasn’t reached a deal to continue extended unemployment insurance, which expired in December.
Roach’s outlook for tempered consumption growth gets some support from Russ Koesterich, the San Francisco-based chief investment strategist at BlackRock Inc. and from Yelena Shulyatyeva, an economist at BNP Paribas in New York.
“The labor market is recovering very slowly, and really the missing ingredient of this recovery has been income growth,” Koesterich said during a Bloomberg Television interview last week. “With income growth very slow, that means that consumption may not grow as fast as some people think.”
The economy’s inability to generate bigger wage gains is also a concern for Shulyatyeva. “Wages have to pick up, and even when we see growth in payrolls we don’t see much of an acceleration,” she said in an interview. “Consumers are still deleveraging, and there’s really not that much willingness on the consumer side to start borrowing again.”
While the job market is in better shape, it’s still weak, said Harvard’s Lawrence Katz, a former Labor Department chief economist. Wage gains have been slow, he said, long-term unemployment remains high, and many of the pluses in the economy mainly benefit upper-income consumers.
“If you are sitting on a large bonus from Wall Street or you’re a post-college graduate in a steady job, you’re probably pretty confident going out and spending,” said Katz, 54. “For a large part of Americans, it’s still a very tenuous economy.”
Rising inequality could become an increasing concern, Katz said, as people in poorer households struggle to access education and job opportunities.
Wealth gains have accrued at the higher end of the income spectrum, while wages have been expanding more slowly. Hourly earnings climbed 1.8 percent in 2013, the slowest pace in three years. Rising home and stock prices primarily benefit those who hold the assets.
“The upper-income earners who have benefited from the rise in wealth have been spending, will continue to spend, but I just don’t think that the lower-income consumers who are still facing high unemployment rates and low wages are going to spend a lot more in 2014,” Michelle Girard, chief U.S. economist at RBS Securities Inc. in Stamford, Connecticut, said in an interview.
The income gap might not matter for economic growth in the short term. As long as consumers in the aggregate spend more, it will add to GDP, said Deutsche Bank Securities Inc. Chief U.S. Economist Joseph LaVorgna.
Through 2014, continued monetary easing from the Federal Reserve could keep providing fuel for the so-called wealth effect. Central bank policy makers have indicated that the Fed will keep its main interest rate near zero even as it slows its unprecedented pace of asset purchases, which it scaled back to $75 billion a month from an $85 billion pace.
Fed policy makers, who meet Jan. 28-29, will probably reduce their bond purchases in $10 billion increments over the next six meetings before announcing an end to the program no later than December, according to a Bloomberg News survey of economists following the latest jobs report.
“The Fed is still easing, they’re just easing at a slower pace,” New York-based LaVorgna said. Consumers have already started to exhibit the sort of vitality that may lie ahead, he said. Retail sales increased 0.2 percent in December after a 0.4 percent advance in November, Commerce Department figures showed. Excluding cars, demand jumped by the most in almost a year.
“The consumer did better in the fourth quarter than at any point in recent history,” LaVorgna said. “Barring a negative, exogenous shock, there is no reason why the consumer won’t spend at a healthy pace this year, and we expect real GDP growth to reach the promised land of 3 percent-plus growth.”