Are Price Increases Killing Consumption?

Written by Steven Hansen

Based on comments on my last post, that there are misconceptions about consumer spending patterns and the effects of price increases.  Consider several potential effects caused by price increases:

  • A consumer can do without.  No vacation, no private school, no newspaper, or no medical insurance.

  • A consumer can perform the same task with lower unit consumption.  Examples are buying a more fuel efficient car, moving closer to where you work.
  • Lower the quality of what you buy – single malt to blended whiskey, steak to hamburger, private car to public transport, change the temperature in your home, big house to little house, Cheesecake Factory to McDonalds.
  • Change the item purchased – switch from fuel oil to natural gas, theatre to satellite TV,
  • Do it yourself – haircuts, gardener, home or car repair / maintenance.
  • Find a cheaper source of a product or service.

Three specific items with relatively large consumer price increases were health care, food, and gasoline.   One would expect these price increase would result in generally taking a larger and larger share of the consumer budget.  Yet, the data says otherwise.

In the graph above, the change in spending pattern was determined by calculating the ratio of the individual elements (health, care, food and gasoline) to the total personal consumption expenditure (PCE).  All values were normalized to 100 for first quarter 2007.  The price index comes from the BEA PCE price index.

I keep writing, but many miss, that there is no such thing as an average consumer.  Each one of us is a different animal with different consumption profiles.  The graphs above represent BEA’s total of all consumption (Joe Sixpack, 0.01%, banksters, retired, farmers, students ….).   To believe a consumer stands still for any long period in the face of price changes is ludicrous.  Price changes beget consumption changes.

On the other hand, I believe the vast majority of consumers spend much of what they make. This is why many pundits (including me) keep their focus on changes in real income.  This was the point of last week’s post.  The downward trend in Real Disposable Personal Income has been broken for at least one month – both on a real and per capita basis.  This is one of the few positive trends currently in play economically.

One other thought emanating from last week’s post is the difference between changes in home values and the changes in home equity.   The blue line in the graph below shows how owner’s equity loss is significantly more than what the home price indices are saying.

As (if) the housing recovery plays out, the increase in home equity values will be a multiple of the change in home prices.  Yes, it will take some time for homeowners to feel (and believe) their home equity is increasing.

Other Economic News this Week:

The Econintersect economic forecast for July 2012 shows continues to show moderate growth. Overall, trend lines seem to be stable even with the fireworks in Europe, and emotionally cannot help thinking this is the calm before the storm. There are no recession flags showing in any of the indicators Econintersect follows which have been shown to be   economically intuitive. There is no whiff of recession in the hard data – even though certain surveys are at recession levels.

ECRI stated in September 2011 a recession was coming . Their data looks ahead at least 6 months and the bottom line for them is that a recession is a certainty. The size and depth is unknown but stated this week was already underway.  A positive result is this pronouncement has caused much debate in economic cyberspace.

The ECRI WLI index value is tip-toeing in negative territory – but this week is again “less bad”. The index is indicating the economy six month from today will be slightly worse than it is today. As shown on the graph below, this is not the first time since the end of the Great Recession that the WLI has been in negative territory.

Current ECRI WLI Index

Initial unemployment claims decreased from 374,000 (reported last week) to 350,000 this week. Historically, claims exceeding 400,000 per week usually occur when employment gains are less than the workforce growth, resulting in an increasing unemployment rate (background here and here). The real gauge – the 4 week moving average – declined from 385,750 (reported last week) to 376,500. Because of the noise (week-to-week movements from abnormal events AND the backward revisions to previous weeks releases), the 4-week average remains the reliable gauge.

Weekly Initial Unemployment Claims – 4 Week Average – Seasonally Adjusted – 2010 (blue line), 2011 (red line), 2012 (green line)

Data released this week which contained economically intuitive components (forward looking) were

  • Rail movements (where the economic intuitive components seem to be indicating a moderately expanding economy);
  • Import portion of Trade balance (less good but still strong);
  • Although we are not able to correlate the FOMC to the economy – it is hard to ignore the effect of quantitative easing

All other data released this week does not have enough historical correlation to the economy to be considered intuitive.

Weekly Economic Release Scorecard:

June 2012 Export Import Price Index
Preliminary July 2012 Michigan Consumer Sentiment
June 2012 Producer Price Index Continues to Show Little Inflation
American Dreams: Over Sold and Over Bought!
Initial Unemployment Claims: Mainstream Reports are False and Absurd
ETF: War of the Goliaths
The New World Order: It Has Been Established, Secretly
China: GDP Growth Slips to 7.6%
Lithium Ion Battery: Struggles to Reach Economies of Scale
Is the Stock Market Ready to Rally?
Recession is not Imminent
Fiscal Cliff Notes: The Certainty of Debt and Taxes
June 2012 FOMC Minutes: More Potential for Slower Growth Seen
Eurozone: Heading Toward 22 Million Unemployed
Public Employment: This Time IS Different
Financial Fraudster Hall of Fame
Wholesale Sales May 2012 Unadjusted Data Looks Fairly Good
May 2012 Trade Data: Although Imports Fell Slightly, Data Good
May 2012 JOLTS Continues to Predict Positive Employment Dynamics
Spain: Save the Royalty, Sacrifice the Peasants
China’s Macroeconomic Miracle: Kleptocracy
ECRI: Recession Has Begun
Week in Review: 09 July 2012
Teen Summer Hiring on Track to Exceed Previous Growth Records
A Brief History of Money
Barclays LIBOR Scandal: The Fed Knew WHEN?
June 2012 Small Business: Index Drop Nearly Wipes Out Gains this Year
Seven Reasons to Sell Stocks Short
National Democratic Party, or How the Democrats Lost Their Way
China: Prices Falling Off a Cliff, Trade Balance Unexpectedly Positive
Consumer Credit May 2012: A Very Positive Data Point Economically
Online Security: Losses Are Tens Of Billions Of Dollars
June 2012 Employment Trends Declines: Employment Is Hard to Trend Anyway
What economists need to know about the modern money creation process
MMT, The Euro and The Greatest Prediction of the Last 20 Years
iPad Mini: Will Crush Tablet Rivals
Insider Trading 06 July 2012: Insiders Selling 11.6 Times More Stock than Buying Stock
Disastrous Weather Patterns Are Sweeping the Globe, More Signs of Global Warming?
Roubini: Next Time Will Be Different
The Week Ahead: All About Earnings
Analyzing a Week That Was No Fourth of July Celebration
ECB Policy for a Liquidity Trap: Firing Bullets in the Dark?
June 2012 Rail Movements: A Good Month
Global Innovation: U.S. Is Middle of the Pack

Bankruptcy this Week:  Dynegy Inc., Patriot Coal, Valence Technology, Ocala Funding, Peregrine Financial Group