“As everybody knows, but the haters and losers refuse to acknowledge, I do not wear a wig. My hair may not be perfect, but it’s mine.” (Donald Trump)
Looking at the cast of characters currently vying for the Oval Office seat, many are left with the sense that the American economy must be in deep trouble. Why else would the electorate be swarming to such seemingly radical options? With the American consumer still the keystone of our more sanguine take on the many risks facing the world’s economy, such concerns obviously need to be taken seriously.
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Most statistics would suggest that this is a great time to be a citizen of the United States. Unemployment is low and still falling, gas is a bargain with wider measures of inflation painting a similar picture for other goods and services. Many measures of crime and violence, domestic and otherwise (Figure 1), continue to plunge lower. Meanwhile, both life expectancy and the survival rate are still trending higher (Figures 2 and 3) and the death rate lower (Figure 4). Income per capita is 10% higher than the levels that marked the end of the last cycle (Figure 5). However, all may not be as it seems.
But not for all...
There is a part of American society where trends in mortality and morbidity are heading firmly in the other direction. White, non-Hispanic Americans, particularly those least educated, are seeing higher suicide rates, more mental health issues and generally deteriorating living standards1. While we are still guessing at the exact causes behind these disturbing trends, the hollowing out of US manufacturing, with low-skilled jobs being outsourced to developing countries, is thought to be an important contributing factor. While globalisation remains an overwhelmingly positive force when viewed from a global perspective, the socioeconomic decline of this segment of American society is a poignant reminder that not everyone benefits equally. Such trends may also help us understand at least some of the popularity of the various presidential hopefuls2, with Donald Trump in particular seeming to do well in states with the highest white, non-Hispanic, mortality rates3.
When trying to explain this lurch towards seemingly more unorthodox presidential candidates on both sides of the political aisle, others have pointed to broader trends in income inequality. Figure 7 illustrates that wage trends in the US remain unevenly distributed, suggesting the gap between rich and poor continues to widen. We do, of course, need to approach such statistics with care. Income growth will be biased downwards for the lower quintiles, mainly because people who grow their earnings faster will move into the higher quintiles – an effect that the statisticians struggle to adjust for. Figure 8 is likely a cleaner representation showing income growth by job category, pointing to a more nuanced conclusion.
Nonetheless, that such income inequality exists in the US and has widened significantly over the last several decades is surely beyond dispute4. The necessarily dispassionate question then becomes whether such disheartening statistics should undermine our confidence in the prospects for US consumption, and therefore influence our recommended asset allocation.
Consumption and Inequality
Intuitively, it makes sense that higher levels of income inequality should result in lower levels of consumption growth. For our part, we’ve leaned heavily on the likely positive effects for global aggregate demand resulting from lower oil prices reducing global wealth inequality. Essentially, a person’s marginal propensity to consume is inversely related to his or her level of wealth – the richer you are, the more you tend to save of your income, according to established academic consensus5.
In theory, this should mean that as you force an increasing proportion of a country’s earnings into the hands of fewer people, you should see the savings ratio rise and consumption growth suffer. However, Figure 9 suggests that the well-documented increases in income and wealth inequality in the US, seen over the last decade in particular, have not yet changed the strong relationship between income and spending at the aggregate economy level. There are multiple potential explanations for this. For us, the most likely one is that income growth has not yet become so unequal that it confounds the positive relationship between income and consumption growth.
Of course, where that threshold of inequality sits is subject to (heated) debate - the US economy may be on the cusp of crossing that line where the relationship between income and spending starts to diverge more meaningfully. There are already plenty of experts (and film directors) telling us where such trends in inequality will inevitably lead. However, history teaches us some caution is warranted here – marginal tax rates have been known to change markedly over time, with societal discontent a vital influence.
A good example of this is the US economy of 1920 – 1930’s, characterised by even higher levels of income inequality than those seen today6 (Figure 10). Under pressure from the electorate, the authorities then opted for higher marginal tax rates for the rich, part of the story that led to a boom in middle income consumption during the 1940s.
Of course, we are not saying such a political shift is inevitable, just that we should be humble in how we think about extrapolating trends into the future, given that most longterm predictions are ultimately confounded by the twists and turns of history. For our part, we would limit ourselves to suggesting that history proves that such problems are not intractable, as long as society wills it.
With regards to our current view of the world, does any of this dent our faith in the US consumer’s ability to keep the global show on the road? So far, no. Yes, income growth is unequal, however, the most important point for us is that most workers’ incomes are growing in both real and nominal terms. While this remains the case, the likelihood is still that US consumption will also grow and the US and global economy with it. Meanwhile, the global transfer of wealth implicit in the plunge in oil prices spans a far larger inequality divide, suggesting we should remain confident of lower oil prices still having a positive effect on global aggregate demand.
1 Rising morbidity and mortality in midlife among white non-Hispanic Americans in the 21st century – Case, Deaton 2015
2 Who Are Donald Trump’s Supporters, Really? – Derek Thompson, The Atlantic, March 1 2016
3 Death predicts whether people vote for Donald Trump, Wonkblog, Washington Post, 4 March 2016
4 Top Incomes in the Long Run of History – Atkinson, Piketty, Saez, 2011
5 Fiscal Policy and MPC Heterogeneity – Jappelli, Pistaferri, 2014
6 Inequality in the Long Run – Piketty, Saez, 2014