Economy Tied in a Spending Knot

Originally posted at Briefing.com

The personal savings rate went up in the first quarter and that's a problem. We said in February that was a risk to the growth outlook, because the more that people save, the less they spend — and spending is what makes the U.S. economy go.

What was learned from the first quarter GDP report is that economic growth isn't going where we all want it to go. That's partly because consumers are saving more and partly because businesses aren't spending like they used to.

In sum, those two happenings are not adding up to strong growth.

Say What?

We took in the view of one strategist from a major investment bank who said the data in the first quarter GDP report was quite positive on consumption. Perhaps he was looking at the column in the report that summarized the fourth quarter, because the column detailing consumption activity in the first quarter was far from being "quite positive" in our humble opinion.

Personal consumption expenditures rose just 1.9%. That was below the 2.3% average growth rate for the prior 15 quarters and the lowest growth rate since the first quarter of 2014.

Spending on goods was up just 0.2%, which was the lowest growth rate since the second quarter of 2011. Spending on services was up 1.1%, which was also the lowest growth rate since the second quarter of 2011.

Business spending was a real downer (literally). Nonresidential fixed investment declined 3.4%, paced by a 23.1% decline in spending on structures. Equipment spending, meanwhile, rose a mere 0.1%.

Consumer spending effectively carried things in the first quarter as it contributed 1.3 percentage points to GDP growth. Nonresidential fixed investment, which encompasses spending on structures, equipment, and intellectual property products, subtracted 0.44 percentage points. That was the first negative contribution since the first quarter of 2011.

A Great Question

Why consumers and businesses aren't spending more is the great question these days. Their reticence in the first quarter was attributed to bad weather by many sources. That's a causal stretch in our estimation on the consumer and business side of things for just about every geographic region other than the Northeast.

Sure, the Midwest and South had some instances of nastier-than-usual winter weather, but if you are a business planning for the long-term, you don't let a brief snowstorm in February or a port slowdown on the West Coast impact your desire to have equipment in place by July if you are confident the demand will be there to justify the investment in the new equipment.

It's not that businesses aren't spending. They are. The issue is that they are being very deliberate with their spending because confidence in future demand isn't strong right now.

That can be seen in the charts below, which show nonresidential investment spending on both structures and equipment has yet to get back to where it was prior to the Great Recession as a percentage of GDP. In fact, on the same basis, nonresidential structures and equipment spending is still running well below its 50-year average.

Newfound Appreciation

The lackluster level of business spending is being derided by many critics as a future liability in that U.S. businesses won't be ready to meet stronger future demand since structures and equipment will be outdated. It's a matter of pointed debate, we know, yet it is currently a matter of economic weakness.

Similarly, so is the consumer's propensity to save more and to spend less.

In the first quarter, the personal savings rate increased to 5.5% from 4.6% in the fourth quarter. It was a somewhat baffling development considering that employment levels were higher in the first quarter than the fourth quarter and considering that the average price of gasoline in the first quarter was the lowest it has been since the first quarter of 2009.

Those two factors alone should have added up to more robust spending activity, never mind that rising property and equity values also boosted the prospects for consumer spending. Since the start of the Great Recession, however, consumers have gained a newfound appreciation for saving more than they used to. That reality has more than few economists scratching their head, wondering if there will soon be an unleashing of pent-up consumption.

Notwithstanding the consumer's desire to save more, consumer spending as a percentage of GDP is still higher today as a percentage of GDP (68.4%) than it was at the start of the Great Recession (67.5%). The reason being -- and this is where the spending knot ties together — is that nonresidential spending is lower today as a percentage of GDP (12.7%) than it was at the start of the Great Recession (13.4%).

In other words, the reason consumer spending is making up a larger share of GDP than it did at the start of the Great Recession isn't because it has accelerated so much as it is because business spending has decelerated.

What It All Means

When consumers and business aren't spending in a robust manner, then it is safe to say the U.S. economy won't be growing in a robust manner either.

A number of reasons have been cited for the lackluster spending patterns:

  • Worries about job security
  • Saving more to cover future health care and retirement needs
  • Saving more to avoid a repeat experience of the last recession in the event of a future crisis
  • Over-investment in prior business cycles
  • A lack of confidence in future demand based on an extended period of relatively weak consumer spending levels
  • A fear of asset bubbles building as a consequence of easy central bank policies around the globe
  • A demographic shift with baby boomers spending less and millenials not having the means to spend more

The bulk of the aforementioned reasons boil down to a fear of the future. Part of that fear is tied to the economic data itself and the lack of consistent growth in it. The first quarter GDP report was another notable case in point.

When consumers and businesses shed their fear of the future, the U.S. economy can take off as hoped and continue to cruise at stronger growth levels.

The data that the Federal Reserve and the rest of us have digested to this point, though, point to thrifty consumers and businesses that continue to fear fear itself. Hence, the economy keeps moving in fits and starts.

Read next: Fed Cites Weather, “Transitory” Factors in FOMC Statement; No Hat Tricks; What About Consumer Sentiment?

About the Author

Chief Market Analyst
randomness