What a Credit-Shy Consumer Means for Growth

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Like many businesses, US consumers remain reluctant to borrow money. 

The Federal Reserve’s latest report on consumer credit, released last week, revealed that consumers remain wary of taking on debt to pay for retail goods. Overall, consumer credit rose $17.3 billion in June, driven once again by non-revolving debt, which rose $16.3 billion. A bulk of that debt was used to finance cars, appliances and student loans. Although the student loan portion was largely attributed to the government's continued acquisition of student loans from private lenders. 

However, the revolving component, which is viewed as an important metric for retailers, rose only $0.9 billion. Aside from big-ticket items—what I call “personal cap ex”—it seems that consumers are keeping a tight rein on credit.


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What’s driving this cautious approach? One reason is the low wage inflation we’ve seen in recent years. While the employment situation has improved significantly in the past two years, income growth has remained stubbornly low. That may be discouraging consumers from spending and taking on more debt. 

Consumer sentiment may also hold some clues. In the July Reuters/University of Michigan consumer sentiment reading, we saw strength in the current conditions component, which gauges consumers’ latest views on the economy. But, at the same time, we also saw weakness in the expectations component, which gauges consumers’ economic outlook for the next six months.

Essentially, the data point to a cautious consumer who is unwilling to take on debt because of uncertainty about the economy. Or at least not the kind of revolving debt that typically carries much higher interest rates, and could prove burdensome if the economy deteriorates. 

Some economists believe consumers’ unwillingness to take on credit-card debt is a bad sign for retailers and the overall economy. But it may not be such a gloomy indicator. Consider that the global financial crisis of 2008-2009 was a scarring event that shaped attitudes toward investing and personal debt just as the Great Depression did so many years before. Consumers are still spending, albeit modestly and selectively. In fact, the second-quarter GDP report showed 2.5% growth in consumer spending. They’re just not willing to take on more debt to do so. 

Still, their restraint could pay off over the longer term because we will likely have more responsible consumers who have stronger balance sheets—consumers who may be less vulnerable to the next economic downturn. 

The Downside of High Spending

Interestingly, there has been some debate that high consumer spending may not necessarily be a sign of a healthy economy. In a January 2012 article, St. Louis Fed economist Bill Emmons wrote, “Standard economic-growth theory suggests that an economy must continuously invest in new capital goods and structures in order to grow, become more productive and raise citizens' living standards over time.” But he goes on to say that economies that invest a higher share of their incomes—or that have access to cheaper investment goods—tend to grow at faster rates.

“… from 1961 to 1970, consumer spending, as a portion of overall spending, was at a relatively low 61.8% while economic growth was at a relatively high 4.1%.”

But Emmons cautions against consumer spending that is so high it “crowds out” investment spending, which can cause the economy to grow at a slower pace. A review of the 60 years from 1951 to 2010 helps support this thesis, indicating that when consumer spending is high, economic growth is relatively low. For example, from 1961 to 1970, consumer spending, as a portion of overall spending, was at a relatively low 61.8% while economic growth was at a relatively high 4.1%.

However, the reality is that consumers and companies seem unwilling to borrow money. Since companies are flush with cash, less borrowing may not hamper corporate spending. In fact, we are starting to see signs of an increase in cap ex spending. But economic growth is highly correlated with the acceleration or deceleration in credit growth; this factor has historically explained GDP fluctuations. So if credit growth remains moderate and spending by companies and consumers remains subdued, then it may lead to lower-trend GDP growth.

The silver lining in this scenario is that we believe interest rates will closely correspond with GDP growth, which suggests the rate-increase cycle will be gradual too.

Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities. 

A Word About Risk: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.

The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

Gross domestic product (GDP) is the value of all final goods and services produced in a specific country. It is the broadest measure of economic activity and the principal indicator of economic performance. 

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