On the one hand, the US consumer is doing great, forming a bulwark against the threat of a recession. On the other, the US consumer can be counted on to carry on pressing the accelerator on his leased car until well after it is already in the ditch.
Data showing the economy expanding at a disappointing 1.2% annual rate in the second quarter illustrates the striking divergence between a robust consumer and the lagging remainder. Consumer spending grew 4.2% in the quarter but everything else is now in recession, with the non-consumption parts of the economy down 0.2 percentage point over the past year.
“If consumers were to wobble in the near-term, it would have profound negative implications for the overall economic outlook. This is why we see an elevated risk of recession, which we estimate to be roughly one in three,” Joseph LaVorgna, economist at Deutsche Bank, wrote in a note to clients.
“There is simply not much else to cushion GDP growth should consumer spending falter, possibly due to an exogenous shock.”
Consumption growth is, in a sense, a mile wide and an inch deep. Job creation remains solid but wage growth is still tepid, meaning that much of the spending is backed by easier and cheaper credit and the rising value of homes and financial instruments.
There are, remember, two Americas: one that spends at or above its income due to relative poverty and one much better off and with a much higher savings rate. A Federal Reserve study released in May found that nearly half of American adults could not meet an unexpected US$400 expense, or would sell something or borrow to cover it.
So a bulwark, perhaps, but not one that will stand up to tough conditions.
Job growth, even as it has been at the lower end, is efficient stimulus because not only do the people who get the jobs spend the money, they spend all of it and very likely a bit more via credit. That works only so long as the jobs keep coming, which should give an insight into why the Federal Reserve has been so cautious about raising interest rates.
Job growth among the financially precarious forms a positively reinforcing cycle with consumption, but a fundamentally fragile one.
Inventories and investment, too high and too low
If we accept that consumers won’t, and often can’t, stop spending unless forced to, then the impulse for a recession would have to be from elsewhere. Global conditions are obviously one possibility, with growth slow or slowing in Europe, Britain and China.
Closer to home, the business sector looks tired, cautious and, as noted, flagging.
Inventories, the stock of goods businesses keep on hand, decreased in the quarter, contributing sizably to the lower-than-expected rate of growth. In real terms, private inventories are close to being in contraction, something that in recent history has gone hand-in-had with either a recession or an imminent one.
Sales were not keeping pace with the previous build-up of inventories, which was not simply due to over-confidence by business, but also to cautious consumers. The last two times the business inventory-to-sales ratio got this high and then began to decline were in 2000 and 2008. The first time the US economy was less than a year from a recession and in 2008 we were smack in the middle of one.
Capital investment is down, driven in significant part by the oil bust, but not entirely. Business spending on equipment fell at a 3.5% annual clip in the quarter and has been in contraction for nine months. Investment in non-residential structures, including things like oil wells, fell 7.9% in the quarter. But even if we exclude mining-related areas, fixed business investment is basically flat for the last two quarters.
US oil prices fell back into bear market territory on Monday, down 22% since early June, after a Saudi price cut.
It is not too hard to imagine a scenario in which we have a US recession that happens not because of some external shock, but simply as businesses slow hiring, banks tighten credit and consumers perforce cut back.
You can see why the Fed would like to get past the US election before moving again. If there is to be a recession, it has little room to cut and few other tools with good track records.
Fiscal stimulus might help, but there is considerable difference in the inflation and other implications if that takes the form of Hillary Clinton building airports or Donald Trump building a wall.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
