Are We Spending Too Much?

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Americans are, once again, no longer letting their meager incomes get in the way of a good trip to the mall. Consumer spending rose 0.7% in the last month of 2010. That was not only a bigger than expected jump in spending, but it was more than double the 0.3% rise in the month before. But here’s the problem: The income of the average American only rose 0.4%. That means our spending rose nearly twice as fast as income. So are Americans digging themselves back into the debt hole that started the financial crisis, and is this a risk for the economic recovery? Perhaps not, at least not yet. Here’s why:

In the past few months, a number of economists and commentators have worried that American consumers were too quickly returning to their spending ways. Here’s what the blog Calculated Risk had to say about it:

When the recession began, I expected the saving rate to rise to 8% or more. With a rising saving rate, consumption growth would be below income growth. But that 8% rate was just a guess. It is possible the saving rate has peaked, or it might rise a little further, but either way most of the adjustment has already happened.

And a few weeks ago in a post about surprisingly strong retail sales in December, I quoted credit card expert Odysseas Papadimitriou, who had this to say:

“My concern is that people have the false notion that when the economy recovers they will be able to return to the levels of consumption they had before the recession,” says Papadimitriou. “There’s just no way to fund that anymore.”

But my look at the personal consumption and income numbers today makes me a little less certain that overspending is a real problem, at least right now. First of all, historically, for the past 20 years, the gap between income growth and consumption growth has averaged 0.015 percentage points. Meaning we typically spend more than we earn. The 0.3 percentage point faster growth in consumption in December is much larger than average, but its not really an outlier. We have regularly had months where the spending gap has been that large or larger. In fact, it is common for there to be a spending gap during recessions because of the drop in income. Back June 2009, the spending gap was 1.5 percentage points. In January 2005, the spending gap was 2.4 percentage points.

What’s more, the amount of money we are laying out in personal interest payments has dropped. In December, Americans spent a total of $185 billion servicing non-mortgage debt. That’s down from $274 billion in late 2007. That’s not necessarily because we have become more responsible and paying off our debt. Much of that drop is probably from lower interest rates (though credit card rates don’t tend to fluctuate that much) and banks writing off credit card debt. But the net result is the same: The American consumer’s debt burden has dropped. The $185 billion that was paid in personal debt payments works out to an average of $593 per person that we are shelling to service their non-mortgage debts per month, namely credit cards and auto loans. That’s down from over $900 in late 2007. More importantly, as a percentage of income, we are spending far less on debt payments than we usually do. During the past 20 years, we have, on average, spent about 7.5% of our monthly income on paying off or just paying the interest on our credit cards and auto loanst. In December, just 4.6% of our income went to non-housing debt. Back in the early 1990s, these debt payments were close to 10% of our monthly income.

Lastly, spending is good for the economy, particularly now. So the rise in spending will likely boost the economy, and jump kick job and income growth. Factor all that in, and it looks to me like fears that Americans are again spending too much are either unfounded or very premature.