Some believe that the U.S. consumer is today’s economic “weak link,” due to record household debt and recent data showing a decline in real wages. Record debt makes sense — given low real interest rates, the long maturity of the debt, and records in home ownership, household assets, credit card usage as a substitute for cash, and auto incentives. Real wages, however, did fall in June, bringing the year-over-year decline to 1.1 percent. Some of the factors causing the decline are temporary, others statistical, and some will persist into 2005. That said, the U.S. consumer will remain resilient.
The logic is as follows:
Real wages remain close to the near-term peak reached in November 2003. That level was the highest since 1979. The current weakness reflects the deflation-reflation-inflation cycle of recent years. During the strong-dollar deflation of the late 1990s, prices were held down more than hourly earnings (which tend to be sticky). Some of that is being reversed now, with prices growing faster. The true pattern of real wage growth won’t likely appear until the ongoing inflation bulge (from dollar weakness in 2003) passes through the economy.
In recent years, real hourly earnings have also fluctuated with energy prices, which have been volatile. Thus, the change in oil and gasoline prices over the last year is causing much of the sharp decline in real hourly earnings in May and June. If oil and gasoline prices stabilize or, better yet, fall, there will be an increase in real hourly earnings. (As a side-note, it would be double counting, to an extent, to consider both high gasoline prices and falling real hourly earnings as restraints on the consumer, since the calculation of real earnings already takes into account high gasoline prices.)
Major national events also dampened the recent wage data. Part of the decline in real hourly earnings in June was a one-time effect from the Reagan funeral. Business closures shortened the work week, reducing overtime and therefore reducing average real wages. This should be reversed in the July data on real hourly earnings, which will be reported with the consumer price index in mid-August.
Over time, real hourly earnings tend to rise. The devaluation of the dollar in 1971 interrupted this tendency by causing a massive inflation, depressing real hourly earnings. (This currency-instability phenomenon also helps explain poor wage performance in many developing countries.) In 2004 and beyond, wages should keep up with inflation — plus something more — although it will take some time for the next strong leg up in real hourly earnings.
Why? The ongoing inflation bulge has to pass through the system and will depress real hourly earnings as it does. In effect, wages were sticky or lagging when deflation was at work and will probably be sticky when other prices are rising. Oil and gasoline prices may also have to stabilize or decline.
In the meantime, however, consumption growth will depend more on job growth, disposable income (which is growing relatively fast in both nominal (6.4 percent year-over-year) and real (3.8 percent year-over-year) terms), and lifetime earnings expectations (helped by lower average unemployment). All of these look strong.
– David Malpass is the chief global economist for Bear Stearns.