Consumer Spending Will Make Or Break The Economy

Personal consumption makes up the vast majority of GDP in the United States, currently around 68-69% (see Chart 1).

Chart 1

So, what people choose to do with their disposable income (i.e. after taxes and deductions) is crucial for the economy: they can spend it, or save it.  This behavioral pattern, called Marginal Propensity to Spend, can be easily deduced by the difference between Disposable Income and Personal Consumption Expenditure, in dollar terms (see Chart 2).

Chart 2

Right before the COVID crisis Americans as a whole spent on average almost 90% of their disposable income (caveat: lower income families routinely spend 100% or more of their income, i.e. they go into debt, while richer ones save and invest more).  The gap between disposable income and consumer spending was running around $2 trillion per year, or just about 10% of GDP, and jumped to almost $7 trillion, a historically unprecedented 35% of GDP (all the figures are annualized) as the Trump administration sent everyone those $1.200 checks which people on lockdown had nowhere to spend (again, not the poorer folks).

The gap has now narrowed to a still enormous approx.  $5 trillion since there are no more handout checks and the US is slowly emerging from the lockdown with consumption boosted by pent up demand.

In my opinion, this is the single most important indicator of the economy’s current condition.  I will be watching closely, but I think that the Marginal Propensity to Spend will remain muted for quite some time and cause the economy to drag, instead of bounce.