January 20, 2010
Consumption Prospects and Rebalancing
In several previous posts, I've emphasized the importance of future US consumption behavior in determining whether the global imbalances shrink, or revert to their pre-crisis configuration.    An IMF SPN by Jaewoo Lee, Pau Rabanal, and Damiano Sandri weighs in on the question of consumption. From the executive summary:
U.S. household consumption declined sharply in late 2008, marking a departure from the trend of a steady increase in U.S. consumption as a share of income since the 1980s. Combining econometric and simulation analysis, we estimate that this departure will be sustained beyond the crisis: the U.S. household consumption rate will likely decline somewhat further from its current level, as the saving rate rises to around 6 percent of disposable personal income (from nearly 5 percent in 2009). Compared to the pre-crisis years (2003–07), this saving rate implies a decline in U.S. private-sector demand on the order of 3 percentage points of GDP.
The paper (also discussed by Free Exchange) provides a nice summary of relevant statistics:
Figure 1: Household Consumption and Selected Indicators, from Lee et al. (2009).
Using a trivariate nonstructural VAR, with Bloom's (2009) uncertainty index, personal consumption-to-disposable income, and household wealth-to-disposable income ordering, Jaewoo and his coauthors obtain these impulse response functions (estimated over 1960Q1-2009Q2).
Source: Lee et al. (2009).
The authors also conduct some robustness tests by way of estimating alternative specifications, and also investigate the results from quasi-structural VECMs. The paper ends:
...Compared to the pre-crisis years (2003–07), the estimated changes in saving and consumption imply a decrease in the U.S. private-sector demand of 2-3¾ percentage points of GDP -- close to a half of the U.S. current account deficit at its peak. This will have substantial effects on global economic development after the current crisis.
That last sentence is key, and is consistent with my view that muted consumption growth will mean easier rebalancing than otherwise.
In this context, I think I would de-emphasize the traditional income-elasticities perspective,   and focus on consumption behavior, going forward. That being said, here is Deutsche Bank's latest take on prospects for the US current account.
Chart 13: from Peter Hooper, Torsten Slok, and Christine Dobridge, "US External Imbalance Prospects," Global Economic Perspectives (Deutsche Bank, January 20, 2010) [not online].
Posted by Menzie Chinn at January 20, 2010 06:16 PMdigg this | reddit
I'm pretty sure we will decrease imports of manufactured goods, by hook or by crook.
The ways I see are other uses of the consumer buck taking precedence.
1)The consumer decides he/she needs at least a 7% savings rate.
2)The governments, state,local and Federal decide they need taxes.
3) Health insurance cost continues to rise with or without a health care bill.
4) By 2014 we are supposed to decide what to do about Climate Change, and the only thing we know for sure is that it will cost money.
5) The social security surplus disappears in 2016, so the government will decide they need more taxes. (They count it as current revenue, which makes the deficit smaller, spend it on other things the year they get it, and put IOUs in the SS fund)
6) We might get inflation. But not wage increases.
7) The Chinese may be able to de-couple from the US in 4-5 years, and re-val the RMB up.
8) The consumer still has to figure out how to do points 1 thu 7.
So that's how we reduce the part of the deficit from imported goods. But then there is oil...that's the hard one and very much depends on both price and volume.
Most countries besides the US usually worry about what they are going to export so they can pay for oil imports. This will be a new departure in thinking from "we have to stop consuming so much.." which seems to be the popular description of the problem in America.
Posted by: Cedric Regula at January 20, 2010 08:47 PM
Weaker US consumption just means more capacity problems for the world economy, even if it is re balanced. It would be really bad if the US decided to balance its budget now and suck that money out of the domestic economy. Though that might re balance trade. Then again, it might not, because a balanced budget might drive the dollar higher.
The best thing for the world now is more consumption, of course in Asia, but not at the expense of the US.
Posted by: purple at January 21, 2010 02:48 AM
We can only guess what future US savings rates will be, especially since they will depend on future policy decisions.
I see the recent increase in the savings rate as driven mainly by involuntary debt reduction, with voluntary increased savings and debt reduction so far playing a relatively minor role. I don't think middle-aged Americans have yet taken on board the implications of future Social Security and Medicare shortfalls. They are still pushing it out of their heads and comforting themselves with a vague notion that the economy still has time to somehow grow out of the problem, although it is hard to imagine how the healthcare industry could so greatly increase its productivity.
Posted by: Tom at January 21, 2010 06:59 AM
In the IMF paper the authors say: "The pre-crisis expansion in credit was driven by mortgages, which accounted for nearly 90 percent of the rise in household debt over the 2000�07 period."
Okay---so if 90% was mortgages, than doesn't that suggest that the bulk of the debt is concentrated in a small percentage of loans? A recent report says that 7 million homeowners have missed payments and are in some stage of default. If those debts are resolved (liquidated) than consumption could resume at prior levels despite all this theorizing about the wealth effect.
explain what is wrong with my theory???
Posted by: scatterbrain at January 21, 2010 07:46 AM
I think Cedric has it about right here.
I would note, however, that best I can tell, the Chinese economy has indeed de-coupled from the US economy. December GDP growth there was reported at 10.7%.
Also, in principle, we should be migrating natural gas to use as a transportation fuel. The gallon cost equivalent of natural gas would be $1.17 today, as opposed to a national average of $2.63 for regular gasoline. Such a migration would help the economy in any number of ways.
Posted by: Steve Kopits at January 21, 2010 01:50 PM
China Watchers are warning us not to be too impressed with the numbers. Very much of it was due to their stim program, a massive go ahead on bank lending(via a reserve requirement reduction) and just plan doctoring the numbers. News in recent days indicates the Chinese government is now moving back to restraint, due to inflation fears and an overheated real estate market.
They did post a big jump in exports in 4Q (these numbers are considered believable because they are verified by the receiving entity), but that can be tied together with the current theory that the big rebound in 3Q and 4Q US GDP was largely inventory re-stocking, and the sustainability is questionable.
I'm a fan of NG too. T. Boone Pickens thinks all big rigs should be converted over. Honda and others sell lots of NG cars elsewhere in the world, so we have the technology. Plus they emit 15%-20% less CO2 than gasoline cars.
NG power plants are half the capital cost of coal plants, and had a cheaper electric production cost when NG sold for $3. They also have half the CO2 output compared to coal. They are also simpler and quicker to build.
Only problem is that if we put all our eggs in one basket, the price goes up. So we still need the "silver buckshot" approach to energy independence and climate change problems.
Posted by: Cedric Regula at January 21, 2010 02:52 PM
Came across more on the China Miracle on the Calculated Risk blog. Either we showed China how to do it, or China decided to show us how it's really done. They beat a 5 year US housing bubble by a factor of two in only one year's time!
Also, I recall some people in the past questioned whether availability of mortgage money has anything to do with housing prices. Here I believe Milton Friedman was right.
And on the possibility of asset bubbles, from China Economic Review: Shanghai mortgages rise 1,600% in 2009 (ht Brian)
Banks lent out US$14.58 billion in new mortgages in Shanghai in 2009, a 1,600% increase from the previous year, the South China Morning Post reported. Of the total, US$5.7 billion went to buyers of new properties and US$8.88 billion to those buying second-hand properties, according to the People's Bank of China. Average prices of Shanghai homes rose 68% from 2008.
Posted by: Cedric Regula at January 21, 2010 05:54 PM
This is a good post, and contains a better explanation of the future of the economy than regression analyses based on other post-war recessions. But as to the current account, the fall off in consumption is being made up with increased public borrowing. The question is, how much of this public borrowing will be financed with foreign loans. To me, foreign purchases of U.S. debt, especially tose that come from official purchases, are a driver of the U.S.
current account deficit, not a passive response to U.S. borrowing.
My main gripe is the treatment of the value of the dollar as a single metric. The dollar is undervalued versus the euro, but dramatically overvalued versus a number of Asian currencies. The longer this malaise continues, the greate the chances that patience will run short and there will be a two-sided fight over deficient global AD, instead of the one-sided grab currently conducted via currency interventions abroad.
Posted by: don at January 21, 2010 06:58 PM
Since so much of the trade deficit gets recycled back to treasuries, as the trade deficit declines, China, and to a lesser extent oil exporters, will have less dollars to buy the fiscal deficit.
So more will have to be financed internally, or taxed. Or I guess maybe the Fed keeps buying them. We will have to see.
One theory is that if China gets less business from the US, it has no need to peg to the dollar.
I think this is over simplified however. Right now the rest of Asia, ex Japan, is really pegging to the dollar to peg to the RMB. Which means weaken their currencies, of course, because much of their trade is either with China or competing with China elsewhere. They have to do this via the Treasury market with their trade dollars, or buy dollars in FX if they don't got 'em, because China does not have open markets and open FX.
One way around the problem of foreign influences creating unwanted currency strength that is often used by other countries is to somehow tax foreign investment, in our case being foreign ownership of treasuries. But it's a funny thought that our government would do such a thing.
Posted by: Cedric Regula at January 21, 2010 08:11 PM
You are only looking at one side of the equation: US demand. You need to factor in global excess output.
Since the US is owner of the world reserve currency, it must increase its imports to absorb this excess output if sustained growth is to occur. This implies the US industrial capacity must further fall - capital flight - and add downward pressure to employment.
Should the economy start to grow, it will only be at the expense of the US savings rate, since, according to the standard model, US debt must rise to offset the rise in asset prices.
Posted by: Charley2u at January 22, 2010 10:32 AM
The balance of payments constraint is that the CA balance is the other side of the coin from the balance on capital account (official plus private). You implicitly assume the intervention is endogenous. One might reasonably argue this way for changes in trade flows (to the extent China maintains a fixed peg). However, one can also view the CA counterpart of the official capital flows to be exogenously determined, in the sense that China is not required to buy any U.S. debt and thus any purchases are the result of conscious decision.
Taxing foreign holdings of Treasuries might help the CA balance, but its main effect might be to cause substitution between Treasuries and other forms of U.S. debt.
Posted by: don at January 22, 2010 11:03 AM
I have a question about consumption and GDP.
I currently pay $60/month for my Sprint cellphone, and another $60/month for by Comcast broadband + Cable TV.
Sprint now has 3G/4G broadband that can be used as a home broadband for PCs as well, with certain modems and USB adapters.
So I have the chance to ditch Comcast, and consolidate both my cellphone and broadband into a single $60/month bill.
So I am saving money, and my living standard has risen.
If millions of people do this, Comcast loses revenue, and lays off thousands of its employees.
GDP also shrinks from all these customers saving $60/month.
So GDP can shrink even as living standards rise.
How is this captured in the productivity stats? In the CPI?
The thousands of people laid off from Comcast have to find work, but it takes time for them to find suitable work, as the skillset has to transfer, etc.
I think we are going to be in a situation of long-term 10% unemployment due to this sort of technological disruption happening a lot. People are cutting costs while also augmenting their living standards, but this curbs GDP growth and causes many large businesses to be churned.
Old publishing houses and bookstores are also under threat from the Kindle and Apple reader. $10/book vs. the old $30/book is great for the consumer, but will shrink the paper publishing industry.
Posted by: GK at January 23, 2010 12:12 AM
The real time federal income tax data doesn't support that the savings rate is 4% or even anything remotely close. The BLS wages and salaries and savings numbers will all be revised sharply down next year. The income tax data shows the savings rate to currently be around 1%.
Posted by: DuganS1 at January 23, 2010 01:02 PM
Your living standards never rise unless you spend the $60 you saved (at some point). Money doesn't have (much) inherent utility, but is rather a means to an end.
So there are two things you can do with the $60 you saved that would increase your utility:
Spend Now: If you spend that $60 on some new adidas, you are simply shifting your consumption away from Comcast and to adidas. If millions of people do this, then Comcast lays off employees and adidas hires employees.
Spend Later: Savings can be considered a shift in the time frame of consumption. So while your lifetime utility has gone up, your immediate utility hasn't changed much at all.
Also, your situation isn't really the typical one. Many savings increases are driven by reduced consumption, not by finding far more efficient ways to achieve the same level of utility.
Posted by: Kevin at January 25, 2010 10:03 AM
OK. But how is a situation like mine captured in the productivity stats? In the CPI?
There has got to be some effect to productivity when the same things is now achieved for half price, as well as some downward effect on CPI.
Posted by: GK at January 27, 2010 08:19 PM
What do you mean by 'productivity stats'?
As far as CPI, if you are replacing a paid service with a free service, I suppose that in some small way you are contributing to price deflation. I don't have too much experience with the CPI beyond the basics though.
Posted by: Kevin at January 29, 2010 07:22 AM
lots of focus on consumption - what about the chances of a production-led recovery? - the FED says non-financial non-farms have v high levels of cash - ip is recovering, cash could be spent on M&A, dividends or investment spending - this investment spending could help consumers recover..
Posted by: jbutterfill at February 12, 2010 02:03 AM