By Ron Robins

US media recently rejoiced in the fact that retail sales were moving higher. But a reality check is needed. Firstly, the purported gains in US retail sales are illusory when adjusted for real inflation rates, reports respected economist-statistician John Williams at shadowstats.com. Secondly, much of the so-called increase in retail sales is accounted for by a small segment of US consumers: the rich. They are spending more as they are benefiting from higher stock prices, says Michael Feroli, who is chief US economist at JPMorgan Chase & Co, and quoted in a January 18 Bloomberg article.

But the prospect of US-inflation-adjusted retail sales continuing higher for more than a few months or a year or two is improbable. To begin with, for Americans, the Europeans and Japanese, amongst others, there is the increasing realisation of much higher taxes required at every level to avoid gutting key federal, state/provincial and local government programmes. The underfunding of government medical, social assistance and pension programmes is so large in most developed countries that even with major cuts to them, higher taxes will be needed. (In the US, most members of President Obama′s National Commission on Fiscal Responsibility and Reform came to the same conclusion.) Thus, higher taxes means after-tax incomes fall and so does spending.

However, for 2011/12 Americans can enjoy some relief in federal taxes due to the extension of the Bush-era personal income tax reductions that were included in the $900 billion stimulus bill passed in December 2010. But based on past results of such efforts, it will only add many hundreds of billions to the US federal debt—which will mean even higher taxes to pay in years to come.

Continuing unsustainable deficits and debt in almost all developed countries will greatly restrain their economic growth for many years. Perhaps the most respected and quoted study on this topic is by professors Carmen M. Reinhart and Kenneth S. Rogoff. In their 2008 study, This Time is Different: A Panoramic View of Eight Centuries of Financial Crises, they found that once government debt reaches 90 per cent of gross domestic product (GDP), economies slow considerably for many years thereafter. By the end of 2010 the US Federal debt at about $14 trillion was flying past that 90 per cent threshold and could exceed 100 per cent this year and continue to rise substantially for years to come.

As forbidding as professors Reinhart and Rogoff′s study is for the welfare of the developed world, it might be even worse. It is probable that most of the countries with debt crises in their study had young and growing populations. That is not the situation today where, uniquely in history, we have fast-aging populations, relatively fewer able-bodied people working, and in some developed countries, actually declining populations. Climbing out of the gigantic debt vortex will tax developed countries in ways that no previously indebted societies have ever had to deal with.

Aging itself also has a dramatic effect on consumption. As people move toward retirement in their fifties, they save more, and in retirement, they spend their savings. The huge baby-boom generation that has fuelled massive US consumer spending for the past twenty years is now moving into retirement and therefore becoming more frugal, further slowing down consumption for decades to come.

Adding to the frugality of developed world consumers will be the realisation of other factors. For instance, Americans now understand that the value of their primary asset, their home, may not rise to anything like the value they were counting on. And in many developed countries numerous private, state, and municipal pension funds are significantly underfunded and might be unable to provide the pension income that their contributors had previously expected.

Additionally, continually rising prices will further enforce frugality among developed world consumers as incomes might not keep up with inflation. Citing the US as an example, in 2007—and therefore prior to the recession—typical household income adjusted for inflation was lower than it was in 1999, according to the US Census Bureau. With no income gains between 1999 and 2007, US households increased their debt levels enormously to fund their spending. Now with highly elevated debt-to-income ratios US families are unlikely, even unable, to travel that road again.

Barring a global recession that runs for an extended period, the cost of food and energy are projected to rise considerably as billions more people rise into the global consumer economy. Also, though studiously avoided by the political and economic elites for fear of public discontent, is the reality that prices may well rise even faster due to the gradual inclusion of costs related to environmental degradation and depletion of resources (i.e. carbon taxes) as the effects of climate change mount.

Of course I have left until last one of the biggest reasons for frugality today. It is the fear of unemployment. Throughout the developed world, unemployment levels are excessively high. Until they come down, many people will fear to spend and instead, save more. Unfortunately, given the above conditions and those explained in many of my previous posts, there is little likelihood of big employment gains throughout the developed world any time soon.

Other than for relatively brief periods, there is not much chance of marked increases in consumer spending in most developed countries in the decade ahead. Their rapidly aging populations are moving from their high spending years to ones of saving, then to frugality in their retirement years. Additionally, developed world consumers will be: severely challenged financially due to increased taxation; uncertainty in the value of their assets; the need to promote personal savings as government medical, pension and social programmes are restricted or eliminated; rising living costs likely unmatched by income gains; and the fear of unemployment.

Just like their predecessors of a bygone era, frugality is becoming the new normal for most developed world consumers.

February 3, 2011

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