Stumbling and Mumbling

Meanwhile, in the real world...

Do consumers know something financial markets don't? That's the question raised by today's figures, showing that high street spending is much stronger than economists expected.
The value of sales grew 6.6% in the 12 months to February, the biggest annual increase for six years. Seasonally adjusted, the  volume of sales has risen 2% since December. And before seasonal adjustment, sales rose by 1.7% in February, the third best February since records began in 1970.
This isn't just because of higher spending in food shops;  sales volumes by non-food stores have risen 1.2% in the last two months and 5.2% in the last 12.
Now, if you believe in the wisdom of crowds or in the permanent income hypothesis, this indicates that consumers are confident about their economic future. It seems they aren't spooked by higher food prices and utility bills - perhaps because they had reined in spending in anticipation; sales volumes stagnated between September and December.
Perhaps, instead, consumers are looking at the fact that their bank deposits are equivalent to over a years' after-tax income; low unemployment; and high profits, which are usually a portent of employment and real wage growth. They're spending because things aren't nearly so bad as the City's panic would have us believe.
What other explanations could there be? City economists are scrabbling around for excuses.  February's unusually bright weather got people into the shops. And the early Mothers' Day also inflated sales, as folk bought harps for their mams.
There's something in these. But they don't fully disguise the important fact - that the real economy is in far better shape than the financial one - something which many "experts", funnily enough, aren't keen to point out.

What consumer problem?

With retailers' share prices falling after M&S's weak trading statement, and the BRC reporting slower sales growth yesterday, it's easy to think consumer spending will fall this year.  But in truth, there are good reasons why it might hold up well. Here are four:
1. Household finances are in decent shape. Their bank deposits grew 8.3% in the year to November, to £930bn (table A4.1 here). This is more than four times their non-mortgage debt, and is equivalent to over a year's disposable income.
2. Retail sales are at a record low relative to house prices. As common sense suggests this ratio should partly mean-revert (if it didn't we'd all end up as misers living in massively-priced homes), it points to sales rising relative to house prices. So perhaps consumers, showing the wisdom of crowds, are  preparing for a weak housing market. US spending has held up well so far despite the housing slump, so why shouldn't it do so in the UK?
3. The mortgage reset problem is overdone. Let's do a rough sum. Anyone who took out a two-year fixed rate mortgage in early 2006 faces a rise in mortgage rates of around 1.2 percentage points. With 1.4 million households due to refinance this year, this implies £2.5bn of extra mortgage payments a year, if we assume an average mortgage of £150,000. This is less than 0.3% of aggregate household income. 
4. Company profits are high. This matters,  because it means pressures on firms to cut jobs aren't especially severe. And if the labour market stays firm, so should spending.
Although these thoughts seem inconsistent with today's market opinion, they are in fact conventional among economists. The consensus forecast (pdf) is for household spending to grow 1.8 per cent this year. Though this would be its slowest rate since - well 2005 - it's hardly a catastrophe.
Does this mean retailers are moaning too much? Not necessarily. I suspect their problems this year will be not so much the aggregate volume of sales, but rather pressure on margins. Sterling's fall will raise the cost of some imported goods - adding to rising costs of rent and wages - whilst intense competition (caused in part by retailers' expansions of recent years) will make it hard to pass these increases on.

Debt and character

Mark Vernon asks:

What does living in a debt culture mean at a more personal level? What is the impact on the sense of morality and self-worth of a society that is sinking into debt, where debt is institutional and systemic?

I'm not sure it means much at all, for three reasons:
1. Debt isn't that high. Britons owe £222.1bn in non-mortgage debt. Yes, this is roughly equivalent to three months post-tax income.  But it's less than a quarter of the money we have deposited in banks and building societies (table A4.1 here). And much - most - of this debt will have been taken on rationally; in the days when you could get six months interest free debt, it made perfect sense to max out your credit card to pay off a bit of the mortgage.
2. Debt is a sign of confidence in future prospects; people take it on, believing they'll be able to repay it - which most do: personal insolvencies have been falling recently.  Surely, such optimism is preferable to a climate of fear and uncertainty, in which folk are scared to borrow.
3. Debt is really rather mundane. It's just a form of transport - a way of moving  one's spending power from the future to the present. Interest is just what you pay the lorry driver for this transport. Why should such dull transactions be morally or socially significant?
And herein lies a puzzle. On the one hand, it seems - with hindsight - that one of Marx's errors was to over-estimate the extent to which a person's work determined their character. But it's a common trope amongst critics of capitalism - for example, Jeanette Winterson here, critiqued by Julie Burchill - that shopping and spending does influence character. But how can this be when we spend so much less time spending money than we do at work?

Push-pin vs poetry

Norm is querying Doris Lessing's claim that the internet is reducing interest in books. The chart below provides a little empirical evidence here, drawing on these data. It shows that the share of total consumer spending going on books has  been remarkably steady in the last few years, at just over 0.4% of total spending, in volume terms.
Indeed, aside from a small drop  in the early 80s - perhaps because of the rise of videos? - book spending has been stable as a share of all spending for years.
If spending on books is a measure of interest in them, this suggests the rise of the internet had, net, no effect on interest in books. The substitution effect identified by Doris is offset by the complementarities described by Norm.
Or did it? One might expect that the decline in libraries would have caused folk to buy more books (as they couldn't so easily borrow them), as should the enormous popularity of Harry Potter.
That these effects don't show up in the data might imply that the internet has depressed interest in books, as Doris claims.
What we might lament, however, is the fact that reading is nothing like as popular as gambling. Counting winnings as negative spending, we spend three times as much on the latter.  Brits, it seems, prefer push-pin to poetry.

The economics of bling

Why do young black men spend so much money on jewellery and flash motors? Is it for the same reason they like jerk chicken or RnB - that there are racial differences in tastes?
No. This new paper (pdf) from the NBER provides a different reason.
One fact disproves the taste theory - conspicuous consumption, relative to income, is much higher among white Alabamans than white Texans, even though the two are otherwise culturally similar.
Instead, what's happening is simply that conspicuous consumption - spending on jewellery, clothing and cars - is a means of signalling one's status, how one is doing relative to one's reference group.
But if one's reference group is really rich, it's difficult to send signals of one's success, as one loudmouth Texan in a London casino a few years ago found out.

"I'm worth a $100 million" he said.
"Really?" replied Kerry Packer. "I'll toss you for it."

So, signalling works better if one's reference group is poor - be the group white Alabamans or young urban blacks. Knowing this, young blacks, faced with a poorer reference group (each other)  spend more on bling than richer whites.
In this respect, they know just what Rousseau knew 250 years ago - that wealth matters because it's a positional good:

If we have a few rich and powerful men on the pinnacle of fortune and grandeur, while the crowd grovels in want and obscurity, it is because the former prize what they enjoy only in so far as others are destitute of it; and because, without changing their condition, they would cease to be happy the moment the people ceased to be wretched (Discourse on the origin of inequality, part II).

US consumers: a wise crowd

There's been some good news for the US economy lately. No, not just the obvious. I mean the Fed's flow of funds data.
These showed that  the ratio of consumer spending to households' net worth fell in Q2, and is now far below its long-term average.
The reason why this is good was described by Uncle Milt in the permanent income hypothesis. The idea here is that consumers try to smooth out their spending over time. So if they see bad times coming, they'll rein in their spending in anticipation, so they won't have to cut it much in the subsequent downturn.
This theory implies that a low ratio of spending to wealth is a sign that consumers foresee hard times, and  that such a ratio will lead to falling wealth but not necessarily falling spending.
And guess what? There's some truth in this. My chart shows that the consumption-wealth ratio has been a great predictor (correlation = 0.69) of moves in net worth in the following two years. When spending's high relative to wealth, wealth subsequently grows - because consumers spent some of the good times in advance. And when spending's low relative to wealth, wealth subsequently falls.
This doesn't mean there's no danger to spending. But it does suggest it won't fall very much, simply because households have been implicitly bracing themselves for lower house prices for a while.
This might be good news for the macroeconomy, but it's bad news for the managerialist class in two senses:
1. A low consumption-wealth ratio predicts falling share prices (though some of this has of course happened since the end of Q2.) The evidence here was put in this paper by Martin Lettau and Sydney Ludvigson.
2. This implies that ordinary Americans, in aggregate, are wiser than fund managers and the forecasting class, as they've (partly) seen falling house and share prices coming.  Which raises the question: could it be that the smart money is to be found on Main Street, not Wall Street?

Cameron talks nonsense

Legend has it that when David Astor was editor of The Observer, someone had to explain to him what a mortgage was. "Do you mean to say that you are all in debt?" he asked his staff. David Cameron - who's inherited £30 million and is married to David Astor's step-great niece - seems to be similarly astounded by his inferiors' indebtedness:

This Government has presided over a huge expansion of public and private debt without showing awareness of the risks involved...Under Labour our economic growth has been built on a mountain of debt.

What this misses is that increased government and consumer debt has been a way of reducing aggregate economic risks. After 2001, there was a danger that falling shares prices and lower capital spending as the tech bubble burst would plunge the UK (and world) economy into deep recession. This was averted by increased government borrowing and lower interest rates that stimulated the housing market. Increased debt was therefore a force for stability.

And as any family with debts knows, higher debt makes us more vulnerable to the unexpected. In short, the increases in debt in the UK have added a new risk to economic stability.

This seems to assume - as the managerialist class must - that people are incapable of judging risks for themselves. But what if consumers have decided that it's safer to borrow more - because  the risk of unemployment is low and because stable-ish inflation means stable (and lower) real interest rates? Higher consumer debt might be a sign of confidence in New Labour's macroeconomic management, not (just) a threat to it.

Over the past decade, the level of personal debt has trebled, to £1.3 trillion. We owe more than our entire national income. So now when interest rates go up, the impact on homeowners escalates.

True. But over the same time our bank deposits (let alone other wealth) have also doubled. At £910 billion, these deposits are more than a year's disposable income.

Insolvencies have quadrupled in the past 10 years, and are now at record levels. Someone goes bust in the UK every seven minutes.

What this doesn't say is that part of the reason for the rise was the relaxation of bankruptcy laws in 2004. The number of insolvencies has actually fallen in the last six months, by 9.3%. And in Q2, the 26956 insolvencies in England and Wales represented around just one in 1600 people. That suggests insolvency is an idiosyncratic problem rather than a macroeconomic one.
There are plenty of reasons to deplore New Labour's economic record. But higher consumer debt isn't one of them.

Ten times earnings?

The papers report that the National Housing and Planning Advice Unit is predicting that house prices will reach 10 times average earnings.
This, though, is not a description of a future reality, but rather a threat. To see why, consider the obstacles to such high prices:
1. They'll become unaffordable. At current mortgage rates, the monthly repayment on a £250,000 mortgage would be equal to all the take-home pay of a £25,000 salary. Even a couple with an income of £50,000 will be spending half their post-tax income on the average mortgage.
2. There's no reason to suppose interest rates will fall as house prices rise. Quite the opposite, if home owners increase their spending in response to higher wealth.
3. High prices will naturally induce selling, as home-owners sell up to buy a place in the sun.
4. High prices will also reduce speculative demand for housing. In a rational world, this'll be because high prices should mean lower expected returns. In the real world, it's more likely to be because of the huge cost of buying. The Beenyitis that's stoked house price inflation recently should therefore subside.
5. There'll be a political backlash. Discontent amongst frustrated buyers is likely to lead to pressure to relax planning restrictions, with the result that more places will be built. This will bid prices down.
Indeed, this is precisely the purpose of the NHPAU forecast - to agitate for more building.

Wisdom in crowds?

Just how wise are crowds? We might be about to find out the hard way.
Todays figures (table I of this pdf) show that net household borrowing - borrowing minus savings - hit a record high of £10.15bn in Q4.
Granted, this is partly payback for low borrowing earlier in the year. Even so, net borrowing in 2006 was 2.1% of GDP. Though less than in 2004, this is comparable to what we saw at the peak of Nigella's dad's boom in 1988.
There are two flatly contradictory ways of interpreting this.
1. It's a vote of confidence in the future. Consumers are borrowing because they anticipate higher incomes in future. This is one implication of the permanent income hypothesis and wisdom of crowds thesis.
2. It's a sign that consumers are feckless and irresponsible. When the bills come in, they'll have to curb spending, possibly causing recession and falling house prices.
The empirical evidence here is ambiguous. High borrowing in 1988-89 did indeed lead to falling spending and house prices, and the improvement in household finances in the early 90s led to stronger spending.
However, before 1988 and since the mid-90s, the link between net borrowing and subsequent moves in spending or house prices has been weak.
We're therefore thrown  back onto our  prejudices about the wisdom of crowds.
And a big issue here is: are individuals' irrationalities correlated or not?
The wisdom of crowds hypothesis assumes they are not, so for each spendthrift, there's a miser. Which raises the question: what sort of mechanisms can cause irrationally high spending to become correlated across people? How strong are they?
In this sense, macroeconomic forecasting is an issue in crowd psychology.

Happiness research and the "pensions crisis"

There's one aspect of the happiness research programme that hasn't got the attention it deserves. It casts doubt on the idea that we're not saving enough for retirement.
One established finding is that older people are happier than younger ones - and retired people are happier (pdf) than workers.
This in itself shows that we were saving enough for retirement many years ago - because today's pensioners, generally speaking, aren't so poor that they're miserable.
But it also suggests young people should spend more than old ones.
Start from the pemise that rational, risk-averse people want to avoid peaks and troughs of euphoria and misery, in favour of a smoother path of well-being. Properly understood, the life-cycle consumption hypothesis says we smooth utility, not spending.
This means we should spend most when we are unhappiest. You can think of the logic here in two ways:
1. When we're unhappy, the marginal utility of consumption is high. There's diminishing marginal utility.
2. Buying stuff makes us happy. Spending is therefore a hedge against unhappiness.
Whichever, young people should spend more than old ones simply because they are unhappier. Our spending should fall as we age; as we get happier anyway, there's less need to spend money.
It's not just the high abstraction of life-cycle utility smoothing that yields this result. So does common sense.
Young women get a bigger kick from buying clothes than do older ones; older women are beyond repair caring so much about their appearance. And older men find it harder to get over hangovers and so don't drink as much.
Rational, forward-looking young people should therefore spend lots of money. They need the kick more than older ones.
Now, you might object here that this doesn't explain young people's actual high spending and lack of saving, because they don't actually anticipate their happiness rising as they get older.
But this isn't the point. In spending heavily, young people act as if they are rationally anticipating a lower marginal utility of consumption in old age.
Indeed, the very fact that there is an age-slope of happiness is evidence that younger people aren't spending enough. Smoothing happiness might require that we transfer more spending from our old age to our youth*.
This, I think, is yet another argument against the idea that there's a looming pensions crisis. The idea that we're not saving enough for our retirement is just a scare story drummed up by a corrupt and incompetent "financial services" industry in an effort to rip off even more people.
* This doesn't, of course, mean transferring wealth from old people to young ones.