The Delusive Contentment of GDP Growth

The Delusive Contentment of GDP Growth

With increasing layoffs, high-interest rates, and rampant inflation, it already feels like the US has fallen into a recession whether it technically is or not. Adding to the rising concern was the significant slowdown in Gross Domestic Product (GDP) growth in the first quarter, which rose at an inflation and seasonally-adjusted rate of 1.1%, well below the 2.6% growth recorded in the fourth quarter of 2022.

GDP is the output of goods and services for sale to the final user generated within a country’s borders. The measure is most commonly expressed as a percentage representing the quarter-over-quarter rate of change in the US, although it is often seen as a year-over-year change in other parts of the world. A positive figure indicates that the economy is growing, while a negative figure suggests that the economy is shrinking, but an official recession is declared after two consecutive quarters with a negative GDP output. While GDP in Q1 2023 was positive, the slowdown compared to the fourth quarter of 2022 points to a recent decline in economic activity which is often a precursor to an official recession.

Consumption was the primary driver of the economy in the first quarter. While this initially appears positive, quarterly consumption growth was due to the impressive 1.4% gain in January versus the prior year when adjusted for inflation. This was the largest increase in nearly two years, but the momentum was short-lived as consumer spending shrunk in February (-0.2%) and was flat in March (0.0%).

The slowdown in consumer spending can be attributed to the drastic rise in essential goods and services prices. Headline inflation for April marked +4.9%, while core inflation, which includes all items less food and energy, recorded +5.5%. Although inflation has been decelerating in recent months, it remains historically high. Inflation also began its hasty ascent in April 2021 and has now surpassed the two-year mark of consistent price increases. As inflation is a year-over-year comparison of the Consumer Price Index, current monthly readings will compare the cost of goods in 2023 against 2022’s prices. However, 2022 figures were already significantly higher than the year before. For example, compared to two years ago, consumers in April paid 13.6% more for the same goods and services!

In contrast, wage gains have consistently lagged behind rising prices, with average hourly earnings only rising by 4.4% in April 2023 versus the prior year and up 10.5% compared to two years ago. Essentially, this means consumers today have less buying power than they did in previous years, despite a boost in pay.

Americans are paying for higher living costs in two ways: 1. dipping into their savings funds. 2. buying on credit.

During the pandemic, consumers across all income ranges built up their savings, helping them weather inflation over the past two years. However, the Federal Reserve notes in their October 2022 bank report that households in the top half income bracket make up the bulk of excess savings, while those in the lower half of earners had roughly $5,500 in extra savings per household. The Fed reported more significant savings for the top half likely only minorly lessened their spending behavior in 2021 as it was driven more heavily by social distancing. Now that COVID-19 restrictions have lifted, this group can travel and purchase again, contributing the most of the rise in consumer spending.

In contrast, many lower-income households likely have already spent a portion or all these savings to pay down debt, invest in equity, or pay for other goods or services rather than maintain them as liquid assets. Economists note that the U.S. personal savings rate in March hovered around 5.1%, well below the decade-long average of 8.9%. The significant drop off in personal savings also coincided with an initial increase in consumer prices observed in April 2021. It can be inferred that as prices began to rise, lower-income households utilized their savings to accommodate the higher costs of food, fuel, and rent. According to a separate Bankrate survey in February, 49% of adults reported having less or no savings compared to a year ago. When those savings are gone, consumers will use credit to cover expenses.

In that same survey, 25% of adults said they would accrue credit card debt to pay for a $1,000 emergency expense, a record percentage since polling started in 2014. This is unsurprising given that American credit card balances reached $986 billion in the fourth quarter of 2022, according to the Federal Reserve Bank of New York, surpassing the record high set in the fourth quarter of 2019 by $59 billion. Economists anticipate that by the end of 2023, credit card balances will exceed $1 trillion for the first time since the New York Fed began tracking!

Bankrate also found that one in three Americans have more credit card debt than emergency savings, the highest percentage since 2010. 45% of Millennials and 44% of Gen X reported having more credit card debt than emergency savings compared to only 25% of Baby Boomers. In comparison, 22% of Gen Z have no credit card debt or emergency savings.

As US consumers’ savings dwindle, credit will be more heavily utilized to cover expenses amidst the Federal Reserve’s highest benchmark interest rate level in 16 years. These soaring interest rates will most impact younger generations as they purchase more on credit, ultimately digging deeper into debt, likely prolonging their financial struggle.

Ultimately, GDP growth in the first quarter of 2023 is not indicative of a healthy economy as it was almost entirely supported by a jump in consumer spending in January fueled by purchasing from households within the top half of income earners. As inflation rises, with price hikes surpassing those already experienced in 2022 compared to 2021, the bottom half of income earners are pulling from their savings to cover additional costs as wage gains made over the past two years have not kept up with the surge in prices. When their savings have been depleted, they turn to credit to make purchases, burying themselves under a mountain of debt exacerbated by high-interest rates. Once consumers reach their credit limits, they are left with few, if any, options as they have nowhere else to turn to afford their current living costs as their debt accumulates. While these struggles may not lead to a deep recession, they could contribute to a longer lasting one as consumers work to pay down debts rather than invest in the economy.