The latest report on personal incomes and outlays showed the expected collapse in personal incomes post the pre-fiscal cliff surge. However, the reversion was more than expected. Today’s charts of the day present the effects of both the reversion in incomes, post the special yearend payouts to avoid the impact of higher taxes, and the impact of the payroll tax increase.
The first chart shows real (inflation adjusted) personal incomes. The effect of the surge in payrolls due to concerns over the “fiscal cliff” is clearly shown, as well as, the subsequent reversal in January as real incomes slid by a whopping 3.6% or $437 billion.
The next chart shows the breakdown of those contributions to incomes. Not surprisingly, the largest factor was in “special dividends”that were paid out at a 15% tax rate on fears that taxes on dividends would rise to as much as 40%. However, these “special dividends”were primarily paid to those evil “one percenters” which are primarily businesses owners who extracted capital from the businesses.
Not surprisingly, real personal consumption tracks real incomes, and with the sharp drop in income in January, higher payroll taxes, and a sharp rise in gasoline prices, it is very likely that real personal consumption will show a larger than expected decline in February.
The reality, as we discussed recently, is that consumers really are not deleveraging their balance sheets much at all. Outside of mortgage debt which has fallen due to foreclosures, write downs, forgiveness, bankruptcies and refinancing – revolving credit has continued to rise. The problem with this is that revolving credit comes at much higher interest rates and the debt service payments continue to erode living standards due to stagnant incomes.
This is clearly seen in the declining trends of personal consumption expenditures. The annualized percentage change in PCE has now fallen to levels that have normally been seen during recessionary periods. Despite trillions of dollars of injections, supports and bailouts personal consumption clearly peaked in 2011, and like the majority of all most every economic indicator, has been waning since.
If we put all of this together we can see a picture of the average American. The chart below shows the annual change in personal incomes combined with the annual change in personal expenditures. What is clear is that consumption has been supported by rising transfer receipts (welfare) and a drop in the personal savings rate which is now at the lowest level since just prior to the last recession. The consumer is clearly struggling to maintain their current standard of living and all indications are that they are going to lose this battle.
While the chart above is a bit cluttered what is important to understand is that the world changed in 1980. Deregulation of the finance industry, combined with continually falling interest rates, allowed for easier, more pervasive, use of credit. This allowed for a higher standard of living, an explosion of investment and a massive surge in productivity due to the technological revolution. However, the shift from manufacturing and production, high economic multipliers, to a finance and service, low multipliers, based economy led to a steady decline in the rate of increase in incomes. The illusion of wealth, spawned by lower interest rates and easy access to credit, which allowed for excess consumption through leverage drained the average American’s ability to save.
It is crucially important to understand the impact of low savings rates on economic growth. The reason, that despite all of the government’s best attempts, that economic growth and employment remains weak can be directly attributed to still high leverage ratios for consumers and low savings rates.
It is only when debt levels fall to sustainable levels, and savings rates rise, that the economy can begin to function normally again. The Federal Reserve’s continued endeavors at the flooding the system with liquidity to induce employment continue to fail because such programs do not positively impact the ability of the end consumer to create increases in aggregate end demand. Ultimately, it is only production and employment that can achieve that goal.
So, while “QE to Infinity” will likely continue to push asset prices higher, at least until the next financial bubble pops, higher asset prices only benefit a small portion of the overall economy. For the rest of America the struggle to maintain their declining standard of living continues as the impact of continued weak economic growth and high levels of real unemployment continue to take their toll.