Friday, March 30, 2007

Gasoline, Disposable Income and The Economy

With oil prices on the rise once again, analysts wonder why higher gasoline prices have not yet crimped demand. They frequently cite inflation-adjusted prices, which are near all-time highs reached back in the 1980's.

However, gasoline and oil expense as a percentage of disposable income is still 25% lower than the high reached in 1981. All other things equal, it means that average retail gasoline prices would have to rise towards $3.50/gal before they create the same "pain" experienced in the 1980's.

Data: US Dept. Of Commerce

Of course, this is a static comparison - the economy is completely different today. For example, household debt is now 130% of income vs. 65% in 1980 and financial obligation payments take up 19.5% of income vs. 15.5% in 1981. The saving rate was 11% then vs. -1.2% today, meaning there was much more earned income left over in 1981 to cushion the impact of higher prices. Today, surplus income has disappeared and additional spending for gasoline has to be met by more borrowing, selling assets or curtailing spending on other items.

There are two reasons why more borrowing is difficult: (a) credit conditions are finally tightening and (b) more debt means more interest expense; since spending already exceeds income, any additional borrowing will be of the Ponzi type (borrowing to pay interest).

This leaves households with two choices: selling assets and cutting spending. I believe both are in the cards. For example, households have been net sellers of equities four years in a row and retail sales are slowing down, although spending on services is still quite healthy.

Bottom line? Though the percentage of income going towards fuel expense is still below the record highs reached in 1981, the overall economy is more vulnerable right now to a rise in oil prices than ever before.

14 comments:

  1. A couple of additional factors to consider in determining the impact of rising gas prices on the overall economy is the improvement in fuel economy from about 14.6 mpg in 1980 for combined car and light trucks to 24.6 mpg in 2004 although the best year was 1987. In addition, the amount of energy required to produce a unit of real GDP output has been cut in half since 1971.

    Nevertheless I agree that the increase in gas prices might just be the stick that broke the camel's back when it comes to consumer spending.


    Despite the headline number of an increase in personal spending and income of .6% in February, adjusted for inflation income only rose .1% and retail sales excluding cars and gas dropped by .3%, the most since August 2004. So the higher price of gas is already starting to take a toll on consumer spending.

    There seems to be something about dramatically increasing gas prices that affects consumer psychology in a way that other price increases do not. Maybe its because we pump our own gas these days and get to watch the price gauge while we are doing it.

    ReplyDelete
  2. The US economy has become much more energy efficient, as you pointed out. Part of the reason is de-industrialization, i.e. goods that took energy to manufacture locally are now imported. I think that if transport costs are included the global energy balance won't look so hot.

    Gasoline prices have an immediate impact because they are directly comparable on a daily basis AND because most people have no choice but to pay the price. The "pissed-off" quotient is very high..:)

    ReplyDelete
  3. Household debt to income ratios
    % of debt to income

    UK 138
    Japan 121
    USA 142
    Germany 102
    Netherlands 185
    Australia 141

    Bank of England (2003)


    Although somewhat dated, I found these comparative household debt figures rather interesting. I guess US consumers are not the only ones carrying unsustainable household debt levels. It seems the only thing keeping consumer spending rising in England, US and Australia right now are housing bubbles.

    Germany and Japan, already at high household debt levels, seem unable to jumpstart consumer spending.

    I wonder what will happen to consumer demand globally once US, British and Australian consumers are finally tapped out?

    Who is going to buy all that stuff coming out of Asian factories?

    ReplyDelete
  4. Interesting...I know for the EU as a whole, household debt/GDP is around 55%, making debt/income slightly higher, maybe 80%?

    Could you provide a link to the BOE data please?

    Thanks.

    ReplyDelete
  5. Actually i pulled it from page 4 of the following thompson report citing the BOE:

    http://www.grant-thornton.co.uk/
    pages/
    press_room-press
    _releases-northern_ireland_and
    _london_named_as_debt_hotspots/
    $FILE/debt+research.pdf


    I would like to get more up to date information breaking down debt levels by category for each country. Let me know if you can find it.

    I would be really interested to see the change in household debt to asset values in both Japan and Germany over the last 15 years. I can't imagine the 50% decline in stock and real estate values in Japan over the last 15 years has improved this ratio.

    I think it's interesting to watch the convergence occuring throughout the world trending toward lower inflation, lower long term interest rates, deficit spending, high debt levels and, of course, asset bubbles.

    It seems to me that both Germany and Japan are trying to export their way out of what would otherwise be severe deflationary recessions. The populations of both countries are significantly older than the US so a strong resurgence of domestic consumption for either is simply not in the cards.

    The Japanese have most of their money in savings accounts and will likely be very conservative going forward.

    Germany has been rescued from its deflationary spiral momentarily by exporting to the rest of the european community but I don't see them going on a consumption binge anytime soon.

    What is even more shocking is how old China's population is getting to be. Given the lack of existing social safety nets or a developed consumer credit culture, I imagine the Chinese will be saving for quite some time to come.

    India is the one country with a massive young population that could possibly represent significant future demand. But I don't think they can ramp it up quick enough to meet the global decline in demand that is coming around the corner.

    We are clearly starting to enter a time where nations are becoming increasingly desperate to export deflation to other countries vis a vis currency devaluation so they don't have to experience job losses. Meanwhile globalization and labor arbitrage continue to relentlessly push down workers wages and income while household debt levels skyrocket. Once household asset values start declining in England, the US, Spain, Australia and Ireland as a result of the housing bubble crash, what will workers' borrow money against?

    Last week's decision to levy tariffs against China is particularly ominous and clearly just the opening salvo.

    ReplyDelete
  6. I have the link for what you asked...

    It's from the OECD (PDF file)

    http://www.oecd.org/dataoecd/19/39/37740324.pdf

    ReplyDelete
  7. My immediate comment on comparing debt to disposable income ratios for different countries is that it is very, very difficult to reach valid conclusions.

    For example, after tax disposable income tends to be smaller as a percentage of gross income in Europe because of the higher level of social benefits (medicine, elder care, etc). This makes the denominator smaller and the ratio larger - but it would be comparing apples to oranges...

    There is no perfect metric, but I think debt/GDP is better in this case.

    ReplyDelete
  8. Thanks for the article.

    I thinks its interesting to note that as a % of GDP, household debt has almost doubled on average across OECD countries over the last 20 years.

    Although average debt service ratios have not risen nearly as dramatically the trend is still up significantly despite dramatically reduced interest rates.

    It's also equally clear that rising house values across OECD countries are attributable primarily to mortgage debt extended to riskier borrowers.

    Not just US consumers are being stretched financially to the breaking point. Consumers across the entire OECD are as well.

    ReplyDelete
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