Broad Demographic Trends Look Good For The Economy

By Dr. Stephen Happel

Anyone who has heard me talk about the U.S. economy knows the importance I place on generational effects to predict real GDP growth. In particular, five generations can be distinguished since 1910:

• Bob Hopers, born 1910 to 1927 and numbering 52 million;
• Sinatra-Elvis-James Deaners (SEDs), born 1928 to 1945 and numbering 47 million;
• Baby Boomers, born 1946 to 1964 and numbering 76 million;
• Gen Xers, born 1965 to 1982 and numbering 59 million;
• Gen Yers (Rainbowers), born 1983 to 2000 and numbering 74 million.

The story is straightforward for the long run. Some 70% of GDP is consumption spending. Given that Baby Boomers are likely to spend—are born to spend—given that Gen Yers are much the same way—they want things now!—and given that both generations are at big-time spending years (late 40s and early 20s), it is hard to imagine a fall in consumer spending for quite some time. Only a major terrorist attack in America's heartland, Congress passing some highly perverse legislation, or a very sharp rise in interest rates will slow this freight train for more than a quarter or two over the next five years.

Following ten consecutive quarters of real GDP growth above 3% after the 2003 tax cuts, growth in the fourth quarter of 2005 did slow to 1.7%, in large part because of the Katrina aftermath and reduced consumer spending. Real personal consumption expenditures (PCE) only increased at an annualized rate of .9%, with the major decline centering on a 16% annualized contraction in spending on durable goods (notably vehicles).

However, the U.S. economy remains robust. First quarter growth in real GDP in 2006 was estimated to be 5.8% as real personal consumption expenditures bounced back by nearly the same percentage. This occurred in spite of $70 a barrel oil and fear mongering about housing values. Surprisingly to the Wall Street economic pessimists, consumer confidence is at a four-year high. What's going on?

Unemployment Is Down
First, jobs are being created. From February 2005 to February 2006, 2.07 million new non-agricultural jobs appeared—a 1.6% increase—and the U.S. economy is on track to create the same number over the next year. The unemployment rate is 4.7%—a four-and-a-half-year low. Since the end of 2005, the percentage of households responding that jobs are “plentiful” has been increasing steadily, while the percentage responding jobs are “hard to get” has been declining steadily. In April, both readings were the most upbeat in over four years, and in recent months hourly compensation has surged 5.7%.

Mixed Signals from Housing Market
A second factor is that the housing market, while slowing down, is not tanking as the pessimists have predicted. Housing starts in April did fall 7.8% to an annual rate of 1.96 million, but this is the same annual rate as in 2004—the second highest total in U.S. history after 2.07 million in 2005. March existing home sales soared 13.8% above February and basically made up for the lost ground in January and February. The median cost of new homes in March was $224,000, down a modest 2.2% from the previous year. Expect to see mixed signals from the housing market over the next year as interest rates rise, but Baby Boomers continue to buy second homes and Gen Xers and Yers buy their first homes.

Wealth Surges
Finally, and most significantly, the wealth of American households (defined as the value of assets minus liabilities) increased $13 trillion the past three years (averaging 9.6% a year), the greatest surge on record. During these three years, the relationship between income and consumer spending—historically one of the strongest in economics—weakened substantially. Yet the surge in wealth offset this. Economic studies find that about 4 cents of every dollar of additional wealth is spent by households. So 4% of last year's $3.9 trillion increase is equal to almost 30% of last year's gain in consumer spending.

There is every reason to believe wealth gains will be strong this year as well. While slowing growth in home prices will reduce additions to real estate wealth, gains in financial assets will make up much of the difference, and improving labor markets and faster wage growth will be another positive. In fact, recent studies find that much of the equity taken out of homes has been put into other financial assets and remains stored away in retirement savings or in liquid assets that can be spent quickly.

Never count the American consumer out.