US consumption

On the same day that Federal Reserve chairman Ben Bernanke said there were “tentative signs” that the US economy was regenerating, bad retail sales numbers sprayed a hefty dose of defoliant over arguments that the worst is behind us. But why were markets so surprised that sales wilted by 9.4 per cent year on year in March? After all, households are deleveraging and, notwithstanding a blip-up in activity recently, the days of homes-as-ATMs are over.

It is impossible to understate how important surging house prices were to consumption. McKinsey Global Institute reckons that from 2003 to the third quarter of 2008, US households sucked $2,300bn of equity from their dwellings. About $890bn was used for personal consumption or for home improvements – a sum exceeding the Obama administration's emergency stimulus package. Another fifth of the total paid down debt, thus boosting spending indirectly, while 45 per cent was invested.

Of course, houses were not the only source of shopping fuel – consumers were also spending a bigger proportion of their disposable income. McKinsey estimates that if the US savings rate had remained steady at the level seen in 1980, a trillion dollars less would have been spent in 2007 alone. That trend has now reversed. But savings are being rebuilt alongside – and in large part because of – a massive reduction in household wealth caused by falling property and other investment prices.

Quantifying the effect that crumbling wealth will have on consumption is inexact. Already since its peak in 2007, household net worth has fallen by $13,000bn, almost equivalent to one year of US output. McKinsey reckons that could be worth about $650bn of consumption. Pretty hefty, but it pales next to the risk to spending from household deleveraging. Assuming no income growth, each 5 percentage point fall in the debt-to-income ratio equates to about $500bn less consumption. With debt-to-incomes currently at 130 per cent, even getting back to 100 per cent will be very painful indeed. Rising incomes would help, but who is asking for a pay rise these days?