It’s no secret why the US economy is still growing and fully employed. Consumers have kept spending, and such activity accounts for two-thirds of US economic activity these days. So, it’s extremely important to track how long consumers will continue to spend.
The best read on spending is how much they borrow, and they are borrowing less. It’s because the Fed has upped their borrowing costs with the Prime Rate now 8.5% and credit card borrowing rates above 20%.
The St Louis Fed’s consumer credit graph shows the sharp drop in borrowing since consumers’ post-pandemic spending splurge. It sends a warning signal that consumers are becoming tapped out and may begin to save more. Recessions begin when that happens.
Borrowing turned negative during the Great Recession of 2008-09 and after the brief two-month post-pandemic recession (gray bar) in the above graph, for instance.
Consumers also began to save more during those recessions. This graph portrays the large uptick in personal savings in 2020 after the same post-pandemic recession. But it has returned to a post-pandemic low since. The question then becomes how much longer can consumers live with depleted savings and begin to save more in such uncertain times?
In fact, a British Lord JM Keynes was the first to identify the cause of modern recessions in 1936 during the Great Depression, when he wanted to understand what had caused it.
He said it was when citizens spirits were low; he called it their “animal spirits”; and they began to save more and spend less. It’s just an economic way of saying consumers were saving more of their income for the bad times; when the unemployment rate ultimately reached 25 percent.
Keynes said, “Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits — of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”
Modern economic theory has evolved into what is now termed behavioral economics, because consumers’ confidence in their future must be taken into account. And it is easily shaken, as Nobel Prize Laureates such as Robert Shiller have explicated in books such as Irrational Exuberance, where many actions to buy and sell—“the spontaneous urge to action”—are not dependent on research, or news that they may not be able to adequately access, but hearsay and rumors.
That is perhaps a harsh judgement on how consumers behave, and also why consumer confidence has been down of late, even though second quarter economic growth doubled to 2.8 percent from 1.4 percent in Q1 in its first reading.
It’s probably also why the Conference Board’s latest Consumer Confidence Index is showing growing pessimism, per Conference Board Chief Economist Dana Peterson, in its latest release:
“The proportion of consumers predicting a forthcoming recession ticked up in July but remains well below the 2023 peak. Consumers’ assessments of their Family’s Financial Situation—both currently and over the next six months—was less positive. Indeed, assessments of familial finances have deteriorated continuously since the beginning of 2024.”
Consumers shouldn’t be blamed for their pessimism, despite being fully employed. Prices are still 20 percent higher on average than before the pandemic. But their moods should considerably improve if and when the Fed finally begins to cut interest rates, and their fears of an upcoming recession lessen.
Harlan Green © 2024
Harlan Green on Twitter: https://twitter.com/HarlanGreen
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