It sounds like common sense. Over-indebted US consumers struggling to make both ends meet will scrimp and save and lower consumption. That will lead to lower growth until the world gets rid of its “global imbalances”. That’s the stuff of which the wall of worry that the markets have had to climb is made of. And yet, Monday’s data showed that personal spending in the US rose for the sixth month in a row. While personal income rose 0.3%, spending rose 0.6%, sending the savings rate down from 3% to 2.7% of disposable income. At least 70% of the rise in income is due to transfer payments from the government, but that still means 30% of the rise in incomes is due to the recovery. US consumer spending rose at the fastest rate in the first quarter, fuelling a 3.2% increase in the gross domestic product.
What gives? The Boeckh Investment Letter provides a clue. It points out that “it is important to keep in mind that the wealthiest 20% of Americans are responsible for 65% of consumption, and that their buying power is more closely correlated with stock market performance than with income”. The rise in the US stock market over the past few months could have, via the wealth effect, led to a pick-up in consumption. But, given high unemployment, for how long can asset-driven gains power US consumption? For a long time, if Ajay Kapur, Niall Macleod and Narendra Singh, the Citigroup analysts who wrote a notorious research piece on “plutonomy” in 2005, were right. The word was coined by the Citigroup analysts to refer to economic growth that is powered by the wealthy in a society and is dependent on their consumption. They said that countries such as the US, the UK and Canada are plutonomies, in which the rich get a very high share of total income. For example, they wrote that in the US, the top 1% of households accounted for 20% of overall US income, the same share as the bottom 60% of households. This share of income has risen under the neo-liberal regime instituted since the 1970s. But here’s their key finding: “If the income shares of the top group is high, a reduction in the savings rate of the top income group (due to asset appreciation, for example) can more than offset any increase in the savings rates of others.” Succinctly put, the researchers said that plutonomy plus an asset boom “equals a drop in the overall savings rate”. They also said that the “global imbalances” were caused by the differences between the more egalitarian economies of Europe and Japan and plutonomies such as the US and the UK. There is no “global savings glut”—the masses save more in Europe and in China, while the rich save less in the plutonomies.
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But hasn’t the crisis made plutonomy as outdated as Bretton Woods II, the theory which argued that global imbalances were benign and sustainable, allowing for the industrialization of the less developed world while bolstering consumption in the rich nations? Well, in a rebuttal to their critics, Messrs Dooley, Garber and Folkerts-Landau, the originators of the Bretton Woods II hypothesis, wrote in a paper last year: “The most likely outcome of these developments is that the Bretton Woods II concept continues to define the global monetary system. That is, industrial and emerging market country fiscal stimulus and direct government intervention in and intermediation of credit markets will eventually provide a boost in growth. As asset values recover somewhat, US households will partly return to a relatively low savings, debt building, equilibrium. Nearer term and more certain, any slack from tired households will be picked up at least for a while by the large fiscal stimuli that are programmed for the next few years. Emerging markets will be even more convinced that reserve accumulation and export-led growth are the safest development strategy in an uncertain world. Even if recovery is low and growth is sluggish, the pattern of imbalances will be the same in the down-cycle as in the up-cycle. We will still have the same outcomes for current account relation between Asia and the US, the same low real risk free rates in the industrial countries, and eventually the same accumulation of foreign exchange reserves, just on a subdued scale.” In other words, it will soon be back to business as usual.
The plutonomy analysis does highlight the impact of rising income inequalities, but it’s a stretch to believe that the consumption of the rich has anything to do with imports from China. The gap in the analysis was filled by the growth of debt, which enabled US workers with stagnant real incomes to continue consuming. But the latest data show that consumer credit in the US is down 6% in the year to February and is at the same level as in June 2007. And consumption out of both transfer incomes and asset inflation is unsustainable.
But there is little doubt that there are powerful forces that want a continuation of the status quo and it’s unlikely that there will be any meaningful reform of the financialization of the US economy, despite the noises that US President Barack Obama is making. As John Bellamy Foster and Hannah Holleman put it: “Today, it is widely recognized that faced with an asset bubble, the capitalist state has little choice but to do what it can to maintain the bubble for as long as possible, and to keep asset prices rising.”
Manas Chakravarty takes a weekly look at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org