Gauging Consumer Spending

 | Aug 31, 2011 | 5:30 PM EDT
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When the U.S. Bureau of Economic Analysis announced Monday that consumer spending rose by 0.8% in July in nominal terms and 0.5% in real terms, I was a bit skeptical.

For car sales, I understand how the Japan earthquake affected availability in dealer showrooms (including U.S.-made models that rely on parts from Japan) and that car sales were already depressed due to inventory shortages. So, I wasn't surprised that purchases of durable goods (which include autos) increased 2% in real (inflation-adjusted) terms compared to a decrease of 1.3% the previous month. Indeed, purchases of motor vehicles and parts accounted for most of the increase in July and for most of the decrease in June, when personal spending fell by 0.1% in nominal terms and was flat in real terms.

In other categories, purchases of nondurable goods decreased 0.3% (after removing inflation) in July and purchases of services increased 0.5%. Did people go to the movies that much more or get more haircuts? The increase in spending on services struck me as a bit odd, but the services component is broad -- it includes airfares, utilities, personal services, brokerage commissions, and so on.

To find out what specific items in this category drove sales last month, we can actually get a very detailed look at precisely what consumers are spending on in one of the appendices to the BEA's Personal Income and Outlays report's Table 2.4.6U, Real Personal Consumption Expenditures by Type of Product, Chained Dollars. This provides more than 300 line items of spending detailed by category. You can find out how much Americans spent on clocks, lamps, flowers, or potted plants if you care to look. Curious about trends in clock sales, I took a closer look at what was driving the spending gains, besides car sales.

What is behind the rest of this spending surge? Utilities. The data are adjusted for price, but weather can influence utility consumption in volume terms. As such, spending on utilities jumped by 4.8% from the prior month. That's not really a discretionary purchase, so it might not give us a sense of underlying consumer demand. Another category that isn't considered shopping in the traditional sense is securities commissions, which surged by 7.5%.

Thus, when you subtract car sales (which rebounded by 5.1% after falling by 4.8% in June), utilities and securities commissions, what you are left with in real terms is spending that only rose by 0.1% -- quite a bit less than the 0.5% gain in headline spending in real terms. The categories I excluded are part of GDP, so they contribute to economic growth but are not what we usually think of as consumer spending and don't tell us much about shopping habits. Also, this increase in spending was financed by a half-point drop in the savings rate as wages and salaries were flat in real terms. Consumers, therefore, paid the electric bill and increased other spending only by saving less.

What can we expect going forward? After the data in this report were compiled, consumer confidence plunged following the debt and deficit debacle in Washington. We recently received two separate reads on consumers' attitudes in August, one from The Conference Board and the other from Thomson Reuters/University of Michigan. In the Conference Board survey, we can see that confidence fell a very steep 14.7 points in August to 44.5, the lowest reading since April 2009. A reading of 90 is considered healthy. Meanwhile, the expectations component, which has a higher correlation to consumer spending than the headline, plunged to 51.9 from 74.9, the second-biggest drop on record and the weakest since April 2009, in the midst of the recession.

The University of Michigan consumer confidence survey confirmed this, with confidence slipping to 55.7 in August from 63.7 in July, the worst level since November 2008, just after the Lehman Brothers meltdown. This level is only slightly above 1980 readings when we had a hostage crisis in Iran, high inflation, high unemployment and a recession simultaneously. The 25% decline over three months is the second largest on record, and the index of consumer expectations stumbled 15% from July levels.

This plunge in confidence can mean two things. First, consumers may cut back spending in August or in later months. The expectations component has a correlation to consumer spending, but it is not strong enough to use confidence measures as quantitatively accurate predictive tools. Thus, while there is a strong possibility that consumers could pull back, the degree to which they might -- or might not -- is uncertain.

Second, there's an add-on effect to consider. The plunge in consumer confidence is not lost on businesses, which have seen their own confidence deteriorate. If businesses are concerned that consumers may cut back on spending, they may curtail hiring, especially with weak sales for the traditional areas of consumer spending noted earlier. This might not be reflected in the August jobs numbers due Friday, but be mindful of the risk of weaker payroll prints in coming months as businesses take a wait-and-see approach.

In the meantime, consumers already foresee fewer jobs. The Conference Board reports that the percentage of those saying there will be fewer jobs rose to 31.5% in August from 22.2%, and this tends to influence spending. We can only hope that this does not become an adverse-feedback loop.

Just remember: What people do is what matters, not what people say in surveys.

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