Monday, October 4, 2010

Where Will Growth Come From?, Part I: PCEs

This week, I'm going to take an in-depth look at the four components of GDP: personal consumption expenditures (PCEs), investment, exports and government spending to see how each may or may not contribute to economic growth over the next few quarters. Let's start with PCEs.

Above is a chart of PCEs percentage change from the previous month. Notice that PCEs have increased for the last four months and in 9 of the last 12 months. Let's break that number down into its smaller components (for more information on what we spend our money on, go to this link).

Service expenditures account for 65% of PCEs. On a month to month basis, this part of PCEs has been increasing at a small but consistent rate.

Non-durable goods -- which account for 22% of PCEs -- were weak for a period of four months, but grew strongly in the period before and after that weak patch.

Durable goods purchases have also been weak.

Above is a rate of the percentage change in PCEs at an annually compounded rate. PCEs are increasing at about 2%/quarter at an annual rate. While this is a lower compounded annual rate than previous expansions, it is still growth.

So, the consumer has been spending, but not at a robust pace. There are several reasons for the slower pace of PCE growth. The most obvious and perhaps most important is the high unemployment rate, which obviously lowers consumer confidence. Here is a chart of the University of Michigan's consumer sentiment:

First, notice the total index (the blue line) has been printing continually lower numbers for the last two expansions. This indicates consumers have been growing more and more concerned over the last decade; it's not a new phenomena. Secondly, notice this expansion is also printing lower numbers overall compared to the last two numbers. So, despite four quarters of growth, overall sentiment is mired in a lower range than previous expansions.

Also hurting sentiment is the housing market, which is still correcting and will probably be doing so far at least another year. The primary issue is a massive inventory overhang in relation to overall demand. Until this inventory is cleared, expect housing to be an issue.

Finally, there is the issue of household debt. According to the latest Flow of Funds report, total household debt outstanding is $13.4 trillion. Total consumer credit outstanding has been decreasing for the last 9 quarters, indicating consumers are moving away from debt.

In addition, the savings rate is increasing, indicating consumers are shunning away from consumption and moving towards saving money for a "rainy."

However, pay is also increasing modestly, providing consumers with new funds. First, here is a chart from the Kansas City Fed:

Notice that average hourly earnings are edging higher even though weekly hours have been moving sideways. Here is a chart of average weekly earnings in 1982/1984 dollars from the BLS:

The number was stagnant for most of last year, but rose strongly during the first half of 2010 year before plateauing over the last few months. In addition, here is a chart of the month to month percentage increase in disposable personal income:

So, there is some new money entering the economy, meaning consumers have the money to make new purchases. However, it appears they are dividing their "expenditures" between savings, paying down debt and PCEs.

So long as the employment situation remains the same -- that is, high unemployment and weak job growth -- there is little reason to think consumers will change their current behavior of slower spending growth, increased savings and paying down debt.