Holiday Sales and The Aftermath

Retail sales muddled through during the holidays, apparently rising at the slowest level in four or five years (3.6%). After inflation, the rise is essentially zero and has come at the expense of profit margins, at least for large department stores where the weakness was pronounced. Shoppers moved their spending downscale towards WalMart and Costco, leaving stores like Macy's scrambling and doing things like staying open round the clock to squeeze every available consumer penny. Not a healthy picture, and one that will likely have repercussions going forward, as exhausted consumers pause to regroup. Let me put it this way: if it took aggressive promotions to achieve decidedly lackluster results at Christmastime, the next couple of quarters look tough, indeed. The saving rate had already dipped into negative territory once again in November, signaling another reason for a pullback after the obligatory gift-giving season.

Poor retail performance is blamed on stretched budgets from a combination of (a) rising costs for fuel and food, (b) vanishing home equity piggy banks and (c) limited wage increases.

Let's examine gasoline first. Looking at price alone provides limited information, because a variety of factors have changed over the years: inflation, incomes, fuel efficiency, number of cars per person. To account for these I produced a chart tracking the number of hours a person needs to work to buy a year's supply of gasoline for the car(s) he owns, currently around 540 gallons per car. Though fuel efficiency has improved significantly from 700 gallons/car in 1967, the number of cars owned per person has grown quite dramatically, going from 0.50 in 1967 to 0.78 currently. All of these factors are combined in the chart below (click to enlarge).

Data: EIA, DOT, FRB St. Louis

For those on minimum wage (currently ~$12.000/yr) driving has has quite clearly become a luxury. But even for average wage earners (currently ~$37.000/yr) real gasoline costs are back to the bad old days of the early 1980s. At current prices of $3.10/gal, they have to work for nearly a month just to pay for gas. No wonder, then, that even middle-class people are scaling down and looking for bargains.

Food expenses haven't become as burdensome, yet. The hour-cost of purchasing one unit of the Consumer Price Index for Food, as published by the Bureau of Labor Statistics, has risen for low-income workers but remained flat for average earners (chart below).

Data: BLS, FRB St. Louis

However, this situation may change quite rapidly if fuel costs remain elevated. Energy is a very important cost factor in food production because of the heavy mechanization and high usage of fertilizer and pesticides in US farming. During the past 12 months crude foodstuff and feed prices are up 20%, a jump that is only gradually now being passed through to consumers, as the crop cycle hits food processors. The chart below shows that there is a potentially large "pent-up" move in retail food prices relative to fuel.

Data: BLS, EIA

"Extracting" home wealth had up to recently boosted spending at the cost of increased monthly financial obligation payments. Such payments are now almost one-fifth of disposable income - a record high despite low interest rates. Of course, home loans don't actually "extract" anything; for this to happen homeowners must sell or refinance at a lower rate and save the monthly difference. According to studies done by the Fed only a minority of homeowners did this - the rest just spent the money.

Financial Obligations Ratio Chart: FRB St. Louis

According to a recent (2007) paper co-authored by Alan Greenspan and published by the Fed, net home equity extraction (i.e. after fees, taxes and points) had been running as high as 10% of disposable income in 2004 and again in 2005 but then declined to 4.5% in the third quarter of 2006 (click chart to enlarge). Given developments in the real estate and mortgage markets since then, it is certain that the extraction has dropped further, perhaps towards 2% of disposable income.

Chart: FRB, Sudden Debt

The difference between 4.5% and 2% translates to $230 billion less per year, or 5% of current annual spending at retail and restaurant establishments.