Friday, August 15, 2014

Consumer Behavior Changes Before Our Eyes

I was looking at charts at the Atlanta Fed’s Economic and Financial Highlights section of their website, and two in particular stand out to me as illustrative of the narrative of the American consumer. The first is a measure of the Personal Savings Rate vs Real Disposable Personal Income. The 2008 – 2009 Recession clearly delineates two distinct periods, which can easily span two decades if one is allowed to extrapolate out to 2020. Going back to 2000, the data show a downward trend in both the Personal Savings Rate and Real Disposable Personal Income. It is important to keep in mind that wages through this period have not been growing.


The macro-disruptive shocks of the Global Financial Crisis occur, and then the US emerges (technically) from recession. Real Disposable Income has since been trending sideways if not with a downward bias, while the Personal Savings Rate has actually started trending higher, according the chart. This represents the key shift in American consumption behavior, as the rising rate of saving represents both accumulating assets and paying down debt; in a word deleveraging.

To fuel the housing bubble and corresponding economic boom, during a period where wages were not rising but the price of most measures of wealth were, savings were drawn down and a ramp-up in borrowing was observed for most Americans consumers.

It seems the debt-fueled flight was too close to the sun and will be remembered for some time to come. Evidenced by arguably the most materialistic culture on the planet; Americans are starting to postpone the gratification of current consumption for the promise of future accumulated benefit.

The second chart illustrates the constituent measures of Personal Consumption Expenditures. A measure of inflation closely monitored by the Fed.

Although the chart represents both core and headline inflation as measured by the index, their combined overall trends and relationship to the Federal Open Market Committee (FOMC) target of 2% will be the extent of the analysis. Again, going back to the beginning of the chart, the data show inflation actually trending higher. This upward trend in inflation, in the years leading up to the Global Financial Crisis, was the factor eroding away at the purchasing power of American paychecks, and so was being offset with the drawing down of savings and the accumulation of debt.

Again, the 2008 – 2009 Recession clearly delineates two distinct periods; the first characterized by inflation trending higher and at times being measured above the FOMC long-term target of 2%. The period after the macro-disruptive shocks of the Global Financial Crisis occur, is characterized by inflation, as measured by the index, trending sideways and persistently below the FOMC 2% target.

This break in inflation that has so many very smart people worried about the soundness of the recovery is actually a hidden benefit. Even though there still is no real upward pressure on wages, the low inflation environment is giving the American consumer room (albeit thin) to save and consume at more modest levels.

Now that the American consumer has demonstrated that sometimes you can teach an old dog new tricks, we wait for Washington to fall in line with the pack.      


Friday, August 1, 2014

Changing Dynamics of an Evolving Economy

In March of 2013, I had a short post titled “Entrepreneurship and the Small Business is going to be the Saving Grace of the US Economy”. Well a couple weeks back, I’m reading an Economic Letter from the Federal Reserve Bank of San Francisco, published July 7th, titled “Slow Business Start-ups and the Jobs Recovery”, and it seems to be carrying the same theme as the March 2013 post, albeit more quantitative by design.

The Economic Letter was highlighting the relationship between housing values as a primary source of financing for entrepreneurial endeavors, and the level of new job creation experienced post 2008-2009 recession compared to previous (deep) recessions. 

Things were coming along smoothly until the topic turned to juxtaposing the rates of job creation post-recession for start-ups versus mature firms over time. Comparing cross-sections of the data, we see that indeed start-ups have been responsible for a disproportionately larger share of new job creation versus mature firms when compared to their relative shares of the overall labor market. An observation which has held true for many previous recessions. 

But when the dots are connected over time, a trend starts to emerge, and not a pretty one at that. That ‘Saving Grace’ that I alluded to in the March 2013 post has been losing its luster. Now, being that there are two aspects to this statistic, it’s only fair to consider them both to pinpoint the culprit. Granted both start-ups and mature firms have been – over the same period of time – creating marginally less jobs post-recession, the start-ups seem to have had an exacerbated decline in growth rate.  The overall resulting effect has been a downward trend in the spread of the growth rate of jobs created post-recession by start-ups over that of mature firms. This is of course worrying, as start-ups have historically been the predominate source of job creation growth.


Getting back to the relationship that the Economic Letter was initially highlighting between home equity values and the level of entrepreneurial activity; home equity values have not been reflective of the trend in the growth rate of start-up job creation. Instead, when looking at historical comparisons, home equity values have been trending higher, and this even includes the housing market crash that was associated with or caused (depending on how you look at it) the 2008 Global Financial Crisis. 

In my opinion, the increase over time of home equity values is a function of the continual increase in the housing stock. Even during the deepest and darkest of recessions, we never stop building homes, we just reduce the number that are built. As well as, the US has not had an outright deflationary cycle where asset prices on a broad base fall over time, represented by negative inflation measures.

That being said, the driver of the observed trend in the job creation growth rate of start-ups has to be more fundamental than depressed home equity values post-recession. Little to no real (inflation adjusted) wage growth, paired with increasing labor productivity over the past almost two decades, speaks more closely to what is being observed with start-up job creation.

In a capital-intensive economy like the United States, investments in technology as well as the pernicious death of manufacturing and heavy industrial production, paired with the simultaneous expansion of services and other less labor intensive sectors of the economy is resulting in less marginal demand for labor. Less marginal demand is being represented by a decline in the growth rate of the more sensitive source of job creation, and less of a premium for labor represented in stagnating wages over time, even as labor has been increasing in productivity this entire time.

Here’s [an opportunity for] a silver lining, as waves and waves of baby boomers retire and leave the workforce, and we continue to see the effects of a falling birth-rate on the supply of labor, there may be some upward and well needed pressures on wages. However, technological development does tend to occur at an exponential rate, and I am yet to see a model that forecasts marginal declines in labor supply at an exponential rate.

No doubt, labor productivity will continue to increase-- driven predominantly by technological development-- while the marginal premium placed on that labor will continue to move in the opposite direction.

Best argument I can make for investing in education.