My colleague, Anthony Randazzo, wrote a column today pointing to the recovery of consumer demand as not being the solution to the economy’s core problem. Keynesians and especially pro-stimulus politicians assert that increasing aggregate demand artificially through fiscal measures will smooth a short-term fall in economic activity and eventually drive long-term economic growth. Sounds easy enough, however, such measures create distortions and push resources into areas that otherwise may not be necessary. While it is true that stimulus programs and increases to unemployment benefits boost demand in the short-term (I don’t believe any economist would deny that), they also change consumer behavior artificially, typically drawing money away from activities like saving and investment, not to mention expanding deficits, debt, and the market’s dependence upon government hand-outs.
I’ve taken the chart from his article and overlaid the year-over-year percent change in consumer credit for the same period to help demonstrate this point.
The chart shows that at the same time of the recovery in aggregate demand there occurred sharp increases in consumer credit. Ironically, ballooning credit was demonized as one of the main causes of the financial crisis as household savings rates actually dropped to negative levels prior to the credit bubble bursting. Now, expanding credit is apparently being encouraged. Total consumer credit hit $2.45 trillion in last week’s report from the Federal Reserve. By comparison that is the same level achieved in June 2007 and is only $130 billion off of its all-time high -- so much for growing savings and paying down debt.
America, however, is a consumer driven economy. Consumption represents nearly three-quarters of GDP. It is the main driver of growth. But should it be the focus of government programs, and should it be how this country gets back on track? If savings and investment are what is needed throughout this employment recession and stagnation, why is consumer credit growing and consumption rising?
Below is a chart of retail sales vs. consumer sentiment since the beginning of 2005 – the same period as the chart above.
Consumer sentiment has trended with retail sales in nearly a one-to-one correlation essentially since the data has been tracked. Not surprisingly, when consumers feel confident about the future, and when they're employed, they buy stuff. When they don’t, they tighten the purse strings. Simple. But something has changed and broken this correlation.
Despite 9+% unemployment and fears about debt and the future (Michigan Sentiment today hit 57.8, near its lows), the American public is out and spending. We’re right back to what we as a country do best – borrow & spend.
Without the pressures of government misdirecting resources, we cannot diverge from these habits. Consumers are not incented to save because savings rates have been manipulated to zero. Government programs have crowded out private investment. An economy cannot grow if the only logical destination for money is in the cash registers of Saks Fifth Avenue.