The Myopic Squirrel and $7 trillion worth of Missing Nuts

It is well-known that a major part of our difficulties today is that like the myopic squirrel, we ate all the nuts in the Fall and didn’t put enough away for the Winter. In other words, residents of the US spent like there was no tomorrow. The spending and the leverage that accompanied it contributed to problems in real estate which spread to the financial sector and then to Main Street. Did we really spend thatmuch? What will it take to restore some balance?

I deal with those questions in this blog. It is sobering to see what Karma has wrought. Can we trim the US consumer’s appetite by $840 billion per year in the coming decade? It won’t be easy but that’s what I think it will take to return to something normal. My calculation is that the US household would have to trim its annual consumption by approximately 42 billion bottles of Jack Daniels. While that seems tough, another calculation finds that if there are approximately 300 million people in the US, then per capita consumer spending would have to fall by about $2,700 per year.

To draw these conclusions I found data on the website of the Bureau of Economic Analysis – http://www.bea.gov/ . I chose to use real (chain-weighted) GDP and Personal Consumption Expenditures (RGDP, RPCE). Using real figures means that the Commerce Department has removed price change from these figures. To examine how consumer spending changed over time, I look at both the value of the amount of RPCE as well as its share of GDP (Share=(RPCE/RGDP)*100). For the year 2009, RGDP was $12.9 trillion. RPCE in the same year was 71% of that amount, or $9.2 trillion. RPCE includes the spending in the US on consumer durable goods (like cars, and furniture), nondurable consumer goods (like food and clothing), and consumer services (like financial transactions and transportation). RPCE does not count goods or services that businesses buy (like plant construction business computers) nor does it count goods and services purchased by foreigners or the government. It also does not include housing construction. Because of the latter, it does not include any of the spending of households on new houses or condominiums. Clearly, if I added the latter, the numbers would get bigger.

So what about this 71% figure for 2009? The table below shows the average of Share over selected periods of time. Notice that for the 18 year time period stretching from after World War II until 1963, Share was a little less than 63%. In the next 16 years – call this from President LBJ to Carter – the ratio increased to about 64%. Share in the 1980s rose to 66%, in the 1990s to 67% and then the last decade it averaged about 70%. At the end of that period it hung in at 71%. Very clearly, household spending has not only increased in absolute terms but it has become an ever larger part of the nation’s output and income – that is, RPCE has been growing much faster than RGDP.

Share of Real PCE to Real GDP for selected time periods from 1946 to 2009

46-63	64-79	80-89	90-99	00-09
62.53	63.91	65.90	66.63	69.63

Okay – so Share is rising, but what else can we say? Let’s make a big assumption about normality. Let’s take the 44 year period from 1946 to 1989 as a norm. Share averaged about 64% during that time. Let’s calculate how much RPCE would have been IF SHARE HAD REMAINED AT 64% IN THE FINAL 20 YEARS. Applying the normal Share of 64% to the years between 1990 and 2009 gives us a normal RPCE estimate of about $8.2 trillion in 2009. The actual RPCE in that year was $9.2 trillion. Subtracting the normal estimate from the actual value, we find that above-normal RPCE was about $910 billion dollars in 2009. Notice that in terms of 2009 figures, RPCE was about 10% higher than if SHARE has been normal. That is, if we want RPCE to return to a more normal share of the national economy, consumers should have spent about 10% less than they did in 2009.

That’s just one year. What if we look at the whole decade from 2000 to 2009? The total RGDP produced over the period was $123.2 trillion. RPCE totaled $85.8 trillion. If RPCE Share was 64% during the whole 10 years, RPCE would have summed to $78.8 trillion – or about $7 trillion less than what was actually spent. In other words – households spent $7 trillion more than normal for a decade. Now that’s starting to look like money! US consumers overspent more than half of a full year’s RGDP in the last 10 years.

What about the future? I estimate that at current trends we will overspend approximately $8.4 trillion in the next 10 years from 2010 to 2019. In other words, we need to trim spending by roughly $840 billion per year for the next 10 years to restore the PCE Ratio to 64% of Real GDP. During that time period RGDP will average $14.7 trillion per year (if it grows at the same rate as the past decade – a lowly 2% per year). If Share remains at 71% then Real PCE will average $10.3 trillion per year. With a normal Share of 64%, Real PCE would average $9.4 trillion. Thus over-consumption would average approximately $840 billion per year from 2010 to 2019.

Let’s add an important perspective. Cutting out this $840 billion each year from 2010 to 2019 does not mean that RPCE has to decline. What it says is that as a nation if we want to return the share of consumer spending back to something normal, then we will have to increase our spending at a lower rate. Notice that should RPCE grow at a more normal rate it will average about $9.4 trillion per year; it will GROW! But it must grow by somewhat less than the $10.3 trillion average if Share is to return to some sense of normalcy.

You can’t have your Jack Daniels and drink it too. We have a clear choice. We can continue to spend like a drunken hooligan or we can try to put our house back in order. Chopping $840 billion per year out of consumer spending will not be easy – noting that if we apply this same analysis to residential construction we will have to tighten the future belt even more – and the result will be slower growth of both output and employment. But not tightening has its price too. Clearly all this spending reduces the nation’s saving and its ability – like the squirrel – to do what’s best for the future. There is no way to return to normal economic health without a return to normal spending. Let’s get on with it.  To set an example, I had breakfast this morning without my usual JD.