The author is editor of FT and chief global economist at Kroll
This is perhaps the most anticipated recession in history. Economists have been predicting a contraction in the US economy since at least April, shortly after the Federal Reserve began raising interest rates. But much like Godot, it has yet to appear. Credit the cash cushion American consumers and businesses have built during the pandemic. But that will eventually go away, and then the economy will take a nosedive.
In 2020 and 2021, generous unemployment insurance benefits, stimulus checks and child tax credit payments helped households save about $2.3 billion in excess savings — the amount above what they would have saved had it not been for the pandemic. This fueled a surge in demand as the economy reopened (fueling upward pressure on inflation). October retail sales posted their strongest gain in eight months. Consumption accounts for more than two-thirds of U.S. gross domestic product growth, and so far spending has remained strong.
But with consumer price inflation at 7.7% in October and median wages up 6%, according to the Atlanta Fed’s wage growth tracker, people’s living standards are falling. As stimulus programs ended last year and the economy reopened — increasing opportunities to spend money — America’s war chest shrunk and the spending extravagance no longer can’t last. Economists’ estimates of the remaining amount range from about $1.2 billion to $1.8 billion.
Forecasts for the life of money also vary, depending on assumptions about the labor market, spending, and GDP. Bank of America projects that at the current three-month average rate of decline in household deposits, it would take between 12 and about 40 months (depending on income quartile) to return to 2019 levels. Goldman Sachs estimates that US households will have less than $1 billion in excess savings by the end of 2023. JPMorgan recently warned that excess savings could be completely depleted by the second half of next year.
There are many reasons to fall on the pessimistic side of these estimates. The personal savings rate fell from 8.3% at the end of 2019 to 26.3% at the height of Covid-19 in March 2021. By September it had fallen to 3.1%, well below the average historical. And despite all the money left in household bank accounts, consumers don’t feel very confident. The Conference Board’s consumer confidence index has been falling since mid-2021.
Consumer debt is rising, another sign that some households are running out of savings. According to the New York Fed, total household debt rose by $351 billion in the third quarter, the largest nominal increase since 2007. Credit card balances swelled 15% from a year earlier, the biggest increase in two decades. And while the rate of delinquencies — debts past due for more than 30 days — on consumer loans and credit cards remains below historical averages, it is rising.
Businesses, like households, have also seen their cash reserves soar during the pandemic thanks to fiscal measures such as the Paycheck Protection Program and ultra-loose monetary policy. New orders for non-military capital goods excluding aircraft – an indicator of capital spending – have remained on a strong upward trajectory since April 2020, suggesting businesses are still happy to spend.
But with borrowing rates continuing to rise and profits likely to decline, this can’t last forever. Business free cash is still well above pre-Covid levels, but has been falling sharply since the third quarter of 2021. Surveys suggest businesses large and small are reducing their capital investments over the coming months, another sign that they are feeling pressure despite their cash flow situation.
It’s a feedback loop to watch. If companies pull out, fewer people will get paychecks. And historically, spending decisions have been based more on job prospects than savings. The United States has a very tight labor market, probably influenced by demand buffered by savings. Unemployment rose only slightly from a post-pandemic low of 3.5%. Average hourly earnings growth slowed from 5.6% in March 2022 to 4.7% in October, which remains well above the historical average. But as the Fed raises rates to dampen demand, the labor market will deteriorate.
In the coming months, the cash war chest will shrink, incomes will suffer and unemployment will rise. Godot never came, but a recession will come, sooner or later. Whether it’s a soft or hard landing, there will be a much thinner cushion of cash to cushion it.
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