Wednesday, August 19, 2009

The misunderstanding of "debt-fueled consumption"

Today I plan to rant just a bit about consumption because I was reading Yves Smith’s article today, and she referred to “debt-fueled consumption” – the now pejorative phrase that just rolls off the tongue. She says:
“no where does the article [referenced WSJ article in her post on the consumption share] acknowledge that the consumption level was unsustainable and debt fueled.”
And this is where I get just slightly irked, because it seems to me that the phrase “debt-fueled consumption” strikes the following chord: every American household was loading up on home equity debt just to buy big ticket items like Hummers and large sofa sets with cup-holders galore from Jordan’s Furniture (a discount furniture shop in the Boston area – generically, every city has one).

I am sure that Yves Smith knows this, but the debt-fueled consumption was more likely paying surging health care bills than buying cute kitchenettes.

Myth 1: The years of debt-fueled consumption went into goods spending, jumping the consumption share of GDP to an excess of 70%.

Reality: The goods share of total consumption has been falling quite dramatically, while the service component surged. Therefore, it is more likely that the debt fueled consumption was going predominantly into the service component (paying service bills).

In Q2 2009, 25% of service spending went to health care – outpatient services (physician, drugs, dentist) or hospital and nursing home services - and 29% of service spending went to housing and utilities – rent, water, electricity, and trash. As such, over 50% of service consumption is more likely to remain stable, even rise faster, with the Boomers out there.

And as for the speculation that workers are postponing retirement due the drop-off in wealth, and consumption will be meager into the medium term, I simply don’t buy it. If anything, the aging population is going to fuel recovery – no matter when they choose to retire. Service sector consumption growth – much of it based on health care consumption - will simply become a larger share of GDP growth (cutting out autos, perhaps), and pick up some of the slack.

And here’s another thing. Myth 2: durables consumption – i.e., autos and furniture – are important contributors to the initial stages of the recovery. It helps, but service consumption is the biggie.

The chart lists the average contribution each GDP component during the initial year of recovery spanning the 1950-2007 (nine recoveries in total).

Reality: The average growth accumulated during the initial stages of recovery (1-yr following the recession’s end) following the last nine recessions is a remarkable 6.43% (consensus forecast for growth in 2010 is currently 2.3%). Only 0.47% of that came from durable goods. A huge 1.67% of that stemmed from the service component of consumption (again, health care and housing).

And as long as service spending rebounds, so too will the economy – even without a big pickup in autos. Inventories are almost a foregone conclusion, the residential construction sector is bound to pick up – 500-600k units is simply unsustainable for a US population that is growing at roughly 1% a year, and growth rates on such a small base can be large.

And here’s another link to jobs that has not been incorporated to many forecasts – growth in jobs means new health care insurance, means added spending on health care.

I could go on, but I won’t.

Rebecca Wilder


  1. I like the analysis of consumption- it wasn't all using houses as ATMs and recklessly flipping houses on huge leverage.

    Health care, among other service costs are spiraling out of control. Why, I used to be able to get a hair cut for a half a penny and a button!

    But here's where I'd differ-

    The debt growth outpaced the income growth for long enough and to enough of a degree that it is/was unsustainable.

    People can and will retrench on services as well as goods, often very drastically. Typical Joe 6 Pack response, I'd say, would be: "I'm going to have to buy gas, food, etc. I'm going to try to get out of debt trouble. I may postpone luxuries like that new car I want, and I'm also not going to be hiring someone to mow my lawn or do my taxes or fix my car/plumbing/roof if I can do it myself."

    And because on aggregate, they can't afford it because of their debt situation, especially with a touchy job market, I just can't see consumer spending recovering for a long, long time.

  2. This analysis is skewed by the timeframe used. The trends would look far different if you started them at 1980 or 1990 - the two points in time associated with declines in the US consumer's savings rate.

    Furthermore, a more thorough analysis of what "debt fuelled consumption" means would look at micro factors as wella s the macro data. My understanding is that one of the main factors increasing health care expenditures is an aging population. Given life-cycle savings analysis AND widespread health insurance, it's unlikely that this element of consumption was debt-fuelled. Furnitures/autos alternatively are purchased by younger people, are discretionary, and can often involve financing from dealers/producers.

  3. Rebecca,

    I agree with Doomsday -- the issue is that consumption was fueled by debt, not that it was spent on durables.

    Secondly, a breakdown of services consumption would be useful. The reason is that you make the implicit assumption that services consumption is not discretionary and therefore should bounce back quickly. Why? When I look around my city (San Diego), I see countless service establishments that probably will not recover well:

    mortgage brokers
    real estate agents
    cosmetic surgery/dentistry
    specialty retailers
    private instructors (music, sports, etc).
    cleaning services
    financial advisors

    I could go on. We are likely undergoing a structural adjustment -- taking out excess capacity in the service sector. This may take years, it is not well understood, and it is not the focus of economic data (which is heavily weighted towards manufacturing).

  4. Hi David and Irrational,

    You all make a very good point: that the structural adjustment is underway, and spending of any kind is shifting down. But I just don't see it in the service component. If I plot the ex-health care component of service consumption (not shown in graph), the share is flat.

    I say that once confidence returns, and with credit availability and income growth, consumer spending will improve while the average saving rate remains elevated. But that's all conjecture - nobody knows.

    And David, I am seeing the opposite scenario than what you are seeing in San Diego - basically, I have recently been struck by how many hair dressers, small gift retailers, and restaurants haven't gone out of business here (in Boston) - they're still trucking along.

    Thanks for stopping by.


  5. Hmm -- I don't see what you find so irksome. Smith's contention is that recent consumption increases were debt-fueled and therefore unsustainable. Your response is that (1) the share of consumption dedicated to goods has been declining while the share dedicated to services has been increasing and (2) services will be a bigger contributor than durables in leading the economy out of recession. Neither of your points seems to have anything to do with the claim that recent consumption increases were debt-fueled and therefore unsustainable.

  6. Hi Anonymous,

    If you read the WSJ article to which Smith was referring, you would see that it is all about "goods" consumption rather than service consumption. There seems to be this idea that auto sales and back to school shopping (for example) is the key to recovery.

    And as you see in the graph, the consumption share is growing during this recession rather than falling....
    Q4 2008 69.8%; Q1 2009 70.5%; Q2 2009 70.6%

    It seems to me that one would have to take China's attempts to control exports out of the equation before the consumption share will drop.


  7. And if this is not a recession but a prelude to depression???

    What then?

  8. Rebecca,

    It strikes me as being irrelevent as to whether the increase and subsequent decrease in consumption is comprised of either goods, or services. What matters is that the funds were spent.

    The metrics that should be followed are Total Personal Income, Disposable Income and Total Expenditures.

    What's been going on is that total expenditures have exceeded income for a good many years; and, concurrently, the rate of saving has been declining.

    The current uptick in apparent savings is more a counting fluke attributable to debt reduction than real savings. For those whose 401-K is down something 40% or more, savings are pretty much a necessity.

    I do, however, agree that Yves post and the WSJ article do make more of the data than is there.

    Enjoy your stuff, especially the fact that you do not try and provide all the noise that's out there.

  9. Rebecca:

    I have a question about your graph. It shows the production of health care as a share of GDP. I think nobody would disagree that we produce more healthcare as a portion of our economy than in the past. But it does not follow that households are paying more. The health care might be paid for by households, business, or government. And since you are measuring production, the healthcare might have been produced and not been paid for at all, for example when a hospital treats an indigent person.

    Of course there may be reasons to suppose that debt is more related to medical costs. Such as medical related bankruptcies. But I don't think that looking at GDP makes the case.



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