Personal Income Up $29.8 Billion in November:
Savings Negative Six Months in a Row
By Dr. Peter Morici, Professor of International Business

Today, the Commerce Department reported in November personal income increased $29.8 billion or 0.3 percent, disposable personal income increased $25.1 billion or 0.3 percent, and personal consumption expenditures increased $25.3 billion or 0.3 percent.

Most significantly, personal outlays exceeded disposable income by $19.1 billion or 0.2 percent. Personal savings have been negative for six straight months, households are critically stressed, and this should raise a caution flag for the Fed.

Consumer spending, which accounts for 70 percent of GDP, has been the primary driver behind the economic recovery, and six straight months of negative savings indicate policymakers cannot count on consumer spending to power growth in 2006. Business investment must pick up the slack.

Consumers have been able to increase spending more rapidly than their incomes by borrowing against the rapidly rising values of their homes and piling on credit card debt. However, the string appears to be running out.

Prices for existing homes will fall this winter, and credit card delinquencies are nearing 5 percent. Auto sales have been weak and holiday retail sales are up only modestly over 2004. Consumers are strapped and exhibiting clear signs of exhaustion.

Housing prices have moderated over the last six months and inventories of unsold houses have increased. The housing bubble may not have burst, yet, but the era of hyper appreciation is over. Households will no longer be able to use home equity loans to rapidly power ever greater levels of debt and spending.

The combination of falling housing values, consumer credit squeezed to near its limits and higher prices for fuels to commute to work and heat homes this winter are squeezing families.

Household liquidity is perilously thin and the Fed, by pushing up interest rates beyond the expected increase in January, would add unnecessarily to this pressure. Inflation poses little threat, and raising interest rates further serves no useful purpose.

The post Katrina run up in energy prices did not create much inflation in the rest of the economy, and gasoline prices and petroleum and natural gas futures did recede in October and November. Recent consumer and producer price reports indicate inflation is well under control.

Although the Fed is very likely to raise interest rates on January 31; however, it should not raise interest rates further.

The nonresidential construction, new home, auto, mortgage and consumer credit industries are potentially vulnerable to excessively high interest rates, and weakness in these sectors could derail the economic expansion.

For the economy to continue expanding at 3.5 percent a year or better, business investment will have to pick up the slack, and the Fed will have to engineer an interest rate environment that permits a cooling of the housing sector without overly stressing consumers heavily in debt and business plans for expansion. Nonresidential construction was the weak link in the business investment in the third quarter, and the Fed should seriously consider the implications of further credit tightening on that sector.

The prospects for weaker consumer and housing sectors and moderate inflation, coupled with the need to encourage business investment, indicate the Fed should end the cycle of interest rate increases soon.

If the Fed does not heed these warning signs of a slowing economy, it risks throwing the economy into a tailspin.