The global financial crisis has ushered in a period of more cautious consumers in the US and to a lesser extent in Australia.
Household savings rates are likely to be higher than over the last decade as households seek to cut debt ratios in the face of reduced credit availability, greater economic uncertainty and constrained wealth.
Retailers will have to adjust and others depending on servicing consumers. It is possibly why inflation has eased in the past six months in this country.
The AMP’s chief economist, Dr Shane Oliver says this will result in a more constrained and fragile recovery in the US.
"In Australia, consumer restraint is likely to be offset by mining sector strength, which is arguably necessary if the economy is to avoid overheating."
About 18 months ago a big concern was that the collapse in wealth, reduced credit availability and economic uncertainty associated with the global financial crisis would trigger a downwards spiral as households seek to repay debt and cut spending, causing a further fall in asset prices and hence wealth, triggering more efforts to cut debt, etc.
In the event this was headed off by monetary easing and fiscal stimulus.
But where does this leave us in terms of household balance sheets and debt levels?
Will consumers go back to their old ways or remain more cautious going forward?
This is not an issue for emerging countries, but is a big issue in the US and Australia.
Household debt levels remain high
The ratio of household debt to income remains high, particularly in Anglo countries.
See the chart below.
The rise in household debt levels prior to the GFC reflected: the increasingly easy availability of credit following financial de-regulation in the 1980s; falling interest rates which made debt more affordable; younger generations becoming more comfortable with debt as memories of serious economic problems faded; and rapidly rising wealth levels which reduced the need to save and supported a higher level of debt.
This went hand in hand with a fall in household savings rates from around 10% of household disposable income prior to 1980, to around zero in both the US and Australia.
As a result, consumer spending rose much faster than income did.
The GFC has sent most of these factors into reverse.
Credit conditions are tighter, economic uncertainty has made consumers more wary of excessive debt and wealth levels have fallen.
So pressure remains to reduce debt.
US households are leading the charge
Household deleveraging is well in train in the US.
This is to be expected.
Thanks to much lower share prices and a 20 to 30% fall in house prices the ratio of household net wealth to income is still 23% below pre GFC levels.
Unemployment near 10% has led to far more cautious attitudes to debt and lending standards have toughened.
Consistent with this household debt has fallen nearly 15 percentage points relative to household income from its high point in 2007.
See the next chart.
With the household savings rate running around six percent from near zero before the GFC, US households are continuing to pay down debt.
Unfortunately there is no easy answer to how far debt levels need to fall.
Debt levels have been rising ever since debt was first discovered.
A simpler approach may be to focus on the saving rate.
With US wealth levels unlikely to recover to 2007 levels quickly it’s likely US household savings rates may persist around current levels or even higher for some years to come.
This implies the world has lost the US as global consumer of last resort.
From the early 1980s till recently US consumer spending grew faster than income (as the savings rate fell).
This made it easy to reflate the global economy in tough times and there was a ready market for excess goods and savings from emerging countries.
However, it’s worth noting it’s not the level of the savings rate which matters but its change.
The big drag on consumer spending and economic growth came as the savings rate rose from 2008 meaning consumption weakened relative to income.
Having now adjusted to a higher rate of savings and debt reduction, consumption can move more in line with income going forward even if US consumers maintain a circa six percent savings rate.
This would mean slower US consumer spending growth than in the pre GFC era but not the contraction some still fear.
Maintaining a six percent saving rate will result in a further reduction in household debt ratios.
The Bank Credit Analyst (a research group) estimates if US households maintain a savings rate of 6% then in 3 to 4 years US household debt will have fallen from 122% of household income today to around 94%, which is where it was in the late 1990s.
This would leave US household balance sheets in good shape, but of course the path to get there will likely be bumpy.
Australian consumers also cautious, but not as much
Anecdotes from retailers attest to a more cautious attitude on the part of Australian consumers.
Australian consumers also indicate a strong desire to pay down debt.
