No Sign of Excess = No Fear of Recession: Households

Milton Ezrati

Chief Economist

Recent news of economic strength has sparked as much talk of recession as anything else. Strange as such a reaction might seem at first blush, those worrying point to two irrefutable facts: 1) Trump’s economic policy agenda seems to have stalled, and 2) the recovery has already gone on far longer than most.

Though it is hard to argue with either point, neither should they raise recessionary fears. To be sure, if Trump fails, especially with tax reform, it will disappoint market expectations and likely force a correction. But not every market correction leads to recession. For the economy, a Trump failure does no more harm than leave policy where it has remained the last 8-10 years, a drag on growth but nothing new and hardly recessionary. Meanwhile those who count months and compare to the averages miss a critical point: recessions do not run on the calendar. Instead, they occur in a response to excesses somewhere in the economy that beg correction. And this economy shows no such pre-recessionary excesses.

Certainly, American households, more than two-thirds of the economy, show nothing worrisome. Past recessions have often erupted because people had out spent their incomes, incurred excessive debts, and had to cut back. So far in this recovery, people have shown none of this behavior. On the contrary, they have shown remarkable prudence. They have kept their spending in line with income, and though the level of debt has grown, it remains manageable relative to income and household assets. Indeed, matters, if anything, suggest that households during this slow recovery, rather than indulge in excess, have put themselves on firmer economic and financial footings.

People of course have increased their spending. But they have done so judiciously. Consumption levels have increased at a relatively cautious 3.4 percent a year during the past five years, only very slightly faster than the 3.3 percent annual rate of income growth. The small difference has contributed to a modest decline in the rate of savings, which has fallen from about 5.0 percent of after tax-income five years ago to about 4.0 percent more recently (not the least because household tax liabilities have increased at a 4.1 percent annual rate during this time). But even today’s reduced savings flow is high by historic standards, suggesting that households face little immediate pressure to cut back.

Meanwhile the composition of income shows improved economic and financial health. Wages and salaries have outpaced other sources of income, growing more than 3.5 percent a year during this time. Wages and salaries in the private sector have done even better, growing 3.8 percent a year. At the same time, reliance on government income support programs has lost significance. Income flows from unemployment insurance, for instance, have fallen almost 60 percent during this time.

Household finances have improved accordingly. To be sure, Federal Reserve (Fed) data show an almost 6.5 percent growth in household debt during just the last three years to a level of $15.2 trillion, long ago passing previous highs. But incomes have grown that much faster so that annual overall income in this country has actually risen from 103 percent of outstanding debt in 2014 to about 108 percent at last count. More telling are figures on the relative burden of debt service. At last measure, the Fed calculates, households dedicate only some 10.0 percent of their after-tax income to interest and principal payments on all debts, down slightly from the about 10.5 percent registered five years ago and nowhere near the about 13 percent recorded just before the last financial crisis.

Generally accepted balance sheet analysis confirms this still-brightening picture. Against the relatively contained growth of household liabilities, Fed data show an almost 14 percent expansion in the assets owned by American households to some $111.4 trillion. This is almost 7.3 times their total liabilities, a considerable improvement on the ratio of 6.8 times recorded only three years ago. Accordingly, household net worth has increased a striking 15 percent during the last three years, to an outstanding amount of about $96.2 trillion.

Some might argue that these favorable comparisons are less secure than they seem. Much of the assets growth, they might point out, reflects stock market gains that could evanesce quickly should trouble emerge. Households then would have fewer assets but still face their entire debt obligation. Though there is no denying such arguments, it is noteworthy that households have also beefed up other more secure holdings. Bank accounts, money market shares, savings deposits, certificates of deposit, and other secure sources of quick cash in an emergency have risen far faster than debt, going from 7.3 percent of all household liabilities three years ago to 10.4 percent more recently. Though this amounts to nothing near large enough to handle all the debt (which would be unprecedented) what matters is that secure assets provide a much bigger cushion than previously.

For those want to worry, or who want to sow fear, nothing is ever safe enough. But apart from such understandably human inclinations, everything in the household sector—in overall terms, in the composition of its income sources, and in its finances—points to improved health and an ability to support spending and the economy going forward. The same can be said about the corporate sector. More on that in a coming article.