The below graph reflects trends in consumption relative to gross domestic product (GDP) growth since 1962. As the year 2000 came to a close, a new trend became apparent: while consumption had remained strong relative to GDP post-1980 supply-side Reaganomics, both nominal GDP and nominal consumption growth rates have been slowing down, and the post-2008 recovery seems to be losing steam. In other words, consumption rates remain quite high relative to GDP, though the growth rate in consumption may be on the wane, as the post-2000 data below suggest.
The 2001 dotcom bubble collapse followed by the 9/11 terrorist attacks added strains to a weakening U.S. economy and slowing consumption. In response to the 2001 economic situation, George Bush enacted the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), and accelerated many aspects of this program in the Jobs and Growth Tax Reconciliation Act of 2003 (JGTRRA). These plans were known as “the Bush Tax Cuts,” and could be seen as doubling down on supply side Reaganomics. The U.S. Congress extended the Bush Tax Cuts post-2010, when the cuts were set to expire.
The Bush Tax Cuts included a variety of tax cuts for all income tax brackets, as well as a more aggressive accelerated depreciation schedule for capital investments. This simply improved cash flow on balance sheets, and supported the economy quite well. Hedge fund managers made a lot of money, bought business use yachts and aircraft, and captured accelerated depreciation on these capital assets, taking some of the pain out of their tax bills. This was welcome news for manufacturers. Supply-side economics seems to work in the short run, though the long run consequences of supply side tax policy remain the center of intense political and economic debate.
As reflected above, the Bush Tax Cuts seemed to be having a positive effect on U.S. consumption, though they began to wear off over the course of 2006. As of 2007 and beyond, both consumption and credit began to contract, and eventually led to the full-blown crisis of 2008. As noted in the prior graph in this series, the Federal Budget Deficit had been improving under the 2001 and 2003 EGTRAA plans, with the budget deficit reaching a mere 1% of GDP by 2007. Interestingly, a report published by the Heritage Foundation, noted that the EGTRAA plans would likely result in the complete elimination of the U.S. national debt by 2010, as tax revenues had started to increase, while spending growth remained contained. EGTRAA seemed to be working—just the supply side fix that the economy needed. The tax revenue trajectory painted a quite seductive positive trajectory, supporting the Heritage Foundation projections for 2004–2007 and beyond. However, this trajectory didn’t last.
Can we blame the 2008 crisis on supply-side economics and Republicans… please?
When the housing and financial crisis arrived in 2008, not even the Bush tax cuts and aggressive capital investment could support the ensuing free fall. The U.S. has resorted to 0 interest rates since December 16, 2008, as well as extensive fiscal policy (government spending), as noted in the prior graph in this series. These post-2008 measures have pulled U.S. consumption out of the period of contraction seen in 2009 and 2010, though current levels of consumption are still fairly weak, and show signs of losing momentum as 2013 progresses.
Even with Bush Tax Cuts, aggressive depreciation for capital investments, 0 interest rates, and large government debts, U.S. consumption growth rates are still below the long-term averages, and show signs of slowing. U.S. Consumer confidence is around 85 as of August—a bit below its longterm average of closer to 90. Bush left office with a debt-to-GDP ratio of 74.1%, at $14.4 trillion. Obama saw debt-to-GDP reach 103.9% by the end of 2012 at $15.8 trillion. In contrast, Clinton left office in 2000 with a debt-to-GDP ratio of 57.7% at $9.8 trillion. Republicans may argue that the Bush Tax Cuts didn’t go far enough, and were not large enough to sustain the economic recovery—financial system issues aside. Democrats may argue that these tax cuts favored the wealthy, the investing class, and capitalists in general, over the the working classes, hollowing out a consumption-driven middle class, as well as the broader economy.
Perhaps the more powerful force in the 2008 crisis was simply soft regulation, which allowed banks to quietly morph into de facto, unregulated, and over-leveraged hedge funds. In all likelihood, the effects of too much leverage in the “regulated” banking system and unregulated shadow banking system thoroughly overwhelmed the causative implications of the tweaking of tax rates and depreciation schedules of the Bush Tax Cuts. Both Republicans and Democrats have recused themselves from regulatory oversights. You could argue that the Bush Tax Cuts, in conjunction with the post-crisis monetary and fiscal policy, are also supporting the ongoing improvement in the post-crisis budget deficit. The U.S. federal budget deficit has improved dramatically from 10% of GDP in 2009–2010 to nearly 4% currently, and Congress expects this deficit to approach 3% to 4% in the coming few years. Hopefully, this trend means that government spending will slowly be replaced with consumer spending in the private sector, or much better yet, investment—the subject of the next and final part of this series.
Should investors see weaker consumption, investment, and government spending soften GDP growth in the future, they may wish to consider limiting excessive exposure to the U.S. domestic economy, as reflected more completely in the iShares Russell 2000 Index (IWM), or consider more defensive consumer staples as reflected in the iShares Russell 1000 Value Index (IWD). Plus, even the global blue chip shares in the S&P 500 or Dow Jones could come under pressure in a rising interest rate environment accompanied by slowing consumption and economic growth. As such, investors may exercise greater caution when investing in the State Street Global Advisors S&P 500 SPDR (SPY), Blackrock iShares S&P 500 Index (IVV), or the State Street Global Advisors Dow Jones SPDR (DIA) ETFs.
RELATED ARTICLES BY COUNTRY
CHINA: For further analysis of how CHINA could be affected by slowing consumption in the USA please see CHINA SERIES—“The Golden Age of Cheap Labor Coming to an End?”
JAPAN: For further analysis of how JAPAN’s export-led recovery could be affected by USA-based consumption trends, please see JAPAN SERIES, “Why Japanese Exports Could Break Out of a 5-Year Slump in 2013.”