Consumers Are Beginning to Spend, But Where Is the Money Coming From?

Retail sales were up 1.6% in March and 10% year-over-year. These are not new highs but, the short-term trend offers some hope at least. However, faced with many and much talked about headwinds, the question really is: Where is the money coming from and is it sustainable?

This is very difficult to answer, on a fundamental basis, because the government is so involved in the economy that it’s hard to tell what is real and what is stimulus. None the less, following are the current positions of the three major branches of economic thought.

Keynesians (Demand-Side Economists)

Consumers are spending, and are being helped by government stimulus programs (the $800 billion dollar stimulus program plus cash for clunkers, mortgage modification, home purchase incentives, extended unemployment benefits, etc.) However, consumers are not spending enough and credit is too restricted for the economy to grow again without government help. The problem now is that stimulus money peaks in June 2010 and then trails off. Therefore, we need to keep interest rates low and we need additional stimulus spending to keep consumers and the economy “growing.”

Here is quote from the Cleveland Federal Reserve that I think sums up the Fed’s position,

“What does all of this bode for a recovery of consumption, the primary driver of the U.S. economy? The data shown here point to a long road ahead for a sustainable recovery. Consumers are paying down loans or defaulting, and those looking for new consumer loans are likely to find that banks are still pulling back on lending, though individuals who can secure a loan face historically low interest rates. Given the hangover of outstanding debt and recent memories of shrinking asset values, consumers may not be motivated to ramp up their expenditures. Rather, consumption will likely recover slowly as households save more and await the return of an improved labor market and the sustainable source of funding—disposable income—that it typically provides for consumption.”

Keynesian Light (Supply-Side Economists)

Consumers are spending more and that spending is becoming broad based. According to Brian Wesbury, Chief Economist at First Trust in Chicago,

“Economic data clearly traces out a V shaped recovery.”

He acknowledges that many headwinds do exist, but not right now --not until some time in the future. His reasons for increased consumer spending include: 1, the pace of debt reduction is slowing (if you pay off less, you have more of your income to spend) and 2, incomes are growing and recovering (a three month trend of incomes show a slight increase.) This is a very short-term view, but Keynesians are focused on the short-term.

Capitalists/Austrian Economists

Capitalists agree that on a short-term basis, consumer spending is increasing, at the margins, but for mostly the wrong reasons. Capitalists look at consumer spending differently. First, the short-term, aggregated numbers do not tell the real story. For example, gasoline prices have gone up about $1.00 over the past year increasing spending in this category. That will/could amount to a lot of consumers spending; but it certainly hasn’t helped the consumer or the economy.

Capitalists contend that it’s not government or consumer spending that is the problem, it’s the lack of investments. Investments and productivity are what generate job creation. That should be our concerned. Savings (ours or foreigners) are needed in order to have investment. Also, the consumer is still deeply in debt and needs time to reduce debt levels (and hopefully save) before meaningful spending can be sustained.

But, where are consumers getting the money?

Here are some other ideas:

1.One source is “strategic defaults.” These are people who are underwater on the value of their homes and can afford to pay their mortgages, but are chose to let their homes go into default and eventually foreclosure. There are currently about 6 million people in the process of foreclosure. These strategic defaults may be adding about $200 billion to annual household cash flows. (Per economist David Rosenberg.) Some of these people have not even been contacted by the bank in over a year.

2.Tax refunds which might be lower than previous years but do fuel consumer spending.

3.Savings rate has dropped from a recent high of 4.6% to 3.1%. That alone would explain a lot of spending.

4.Additional stimulus programs to come.

Short-term, it appears that consumers are spending more and adding to GDP (which certainly looks good ;) but long-term, we need to solve the problems that caused this recession in the first place and that will take time not money.

Comments always appreciated.