Could This Break the Economy?

Dave:
Hey, everyone. Welcome to On The Market. I’m your host, Dave Meyer. And today, I’m going to be diving deep all by myself into a very hairy, confusing, but important economic topic. We’re going to be talking about what the heck is going on with the American consumer. If you follow headlines or read pretty much any news, you’re probably seeing really conflicting signals. People are spending a lot of money, but debt is also soaring. Economic confidence is down, but big purchases seem to be up. And I know that what’s going on with American consumers is not directly related to real estate, but it is still a super important topic that impacts every single investor and just our everyday lives. In the US economy, consumer spending actually makes up 70% of gross domestic product. That basically means that what consumers are doing makes up 70% of the entire economy.
And obviously, even though that’s not directly related to your particular investments or which homes you may be buying or selling, it obviously has impacts on rent prices. It has impact on whether people are going to be moving, what your tenants are thinking about, how comfortable you might be in making an investment, what risk you’re willing to take on. Today, we’re going to dive deep into this topic. And let me warn you guys, I guess it’s not a warning, but let me just tell you that we’re going to go into a lot of different numbers. We got all sorts of different stats. We have lots of different graphs. Well, actually, I guess you guys can’t see the graphs, but I can see the graphs and I will describe them to you. Or actually, I wrote a blog post on this on BiggerPockets that came out a couple of weeks ago, so you can also check that out if you want to see the graphs. We’ll put a link in the description. Today, we’ll find out what is going on with the American consumer. But first, we’re going to take a quick break.
First things first, when we talk about consumer spending, let’s just talk about the highest level possible thing, which is known as personal consumption expenditures. That is just a fancy word for how much consumers are spending. And people are spending a lot. Despite recession risk, despite inflation, despite higher interest rates, consumer spending is still up and is, in fact, at an all time high. But remember that when we were talking about all of this money that is being spent by consumers, that there has been a lot of inflation over the last couple of years. There has been a lot of new money introduced to the monetary supply. And so that means although the total figure, the total amount of money that has been spent by consumers in the last quarter, it is devalued dollars. And so although this top line number is huge, we have to dig in deeper to get a sense of are people feeling good about the economy, what they’re spending on, can they afford the things that they are buying.
And beyond this one top line measure, things get a little bit murky. We’re going to dive into a couple of different subsections. We’re going to talk about consumer sentiment. We’ll also talk about consumer debt because that is a really hot topic right now. We’ll also talk about the labor market and try to make sense of what is going on in the big picture. When we look at sentiment … And the reason I like to look at consumer sentiment is because it’s an important lead indicator. And if you’re not familiar with that term, a lead indicator is basically one metric or statistic that helps us predict or forecast another one. And I like consumer sentiment because it is a good lead indicator for consumer spending. When we’re talking about the big picture, it stands to reason that if sentiment declines, consumer spending might decline.
And if consumer spending declines, then GDP might decline. That could send us into a recession. I know it’s like a couple of orders of thinking here right now, but that’s why consumer sentiment is so important, at least in my opinion. Now, what is going on with consumer sentiment? This is measured by surveys, typically by the University of Michigan. That is the most reliable one. And what’s happening is sentiment has actually been up this year. If you look at the start of 2023, actually in the end of 2023, consumer sentiment started to rebound. Now, it’s important to know, because you’re not looking at the charts that I’m looking at, that prior to that rebound, it had fallen off a cliff. This index starts at 100, so that means average is about 100, and that’s where we were heading into the pandemic.
Consumer sentiment was relatively normal. Then when the pandemic happened, completely nose dived. It went down to about 75. That basically means that consumer sentiment … Basically, you can think of it declined 25%. Then through part of 2020 and into 2021, things got a little bit better. Then when people realized COVID was around for a couple more years, it absolutely plummeted to about 55, but it has now rebound up to 68. That’s a complicated way of saying that consumer sentiment has been climbing, but is way down from normal levels. But the key thing that has changed is just in the last month, it actually started to fall. If you can tell from me naming all these numbers, it has been very volatile, but it is starting to come down again. And I think as we talk about the big broad picture, that is really important.
For a little while in 2023, people were starting to feel better about the economy. Now they’re feeling slightly worse. It only fell a little bit. And so this is going to be important indicator to watch, is if that consumer sentiment declines even further. Now, when I do my research into the economy, I don’t like to just look at a single source. That data that I just mentioned is from the University of Michigan, but I also like to look at some surveys from the Conference Board that also measures sentiment. And what you see from the Conference Board really lines up with what you see from the University of Michigan, that over the course of 2022 and 2023, things were looking a little bit better, and then they start to decline. Now, the Conference Board, they ask a slightly different question. It’s not just consumer sentiment.
They ask, “How do you feel about your family’s current financial situation? Is it good or bad?” And for the last year or so, it’s been flat. It’s been relatively low, but it has been flat. But over the last two months, it has started to decline. And so when I look at these two data sets together, what I can see is a trend emerging, is that people were feeling uncertain about the economy. Things … Sentiment wasn’t high, but it was at least stable. But over the last month or two, people are starting to see decline. Now, that is kind of interesting because actually, if you look at a lot of broad measurements of the economy, the economy is doing pretty well. Just today, October 26th when I’m recording this, GDP numbers came out and GDP grew at 4.9% year over year, which is a humming economy. And it’s important to know that that 4.9% number is above and beyond inflation.
In other words, the economy grew almost 5% above the rate of inflation. That, to me, sounds like a good economy. And as we’ll talk about, the labor market has remained relatively strong, but at the same time, despite those facts, consumer sentiment is declining. And that brings us to consumer debt. People are spending, sentiment is slipping, but debt is at an all time high. The first metric I like to look at when we look at consumer debt is just the broadest thing, it’s called US total household debt. And that has hit a whopping $17.6 trillion. That is a very large number, obviously, and it is the all time high. But again, when we look at these absolute numbers, we need to remember that these are somewhat devalued dollars because of the increased monetary supply. But the other thing you should know is that it is starting to level off.
Consumer debt really has gone up since … it’s sort of … The way it’s trended over the last couple of years, it was going up to the Great Financial Crisis. It went down for a couple years. Then since 2013 or so, it has been marching up relatively steadily. And now, the last two months are actually the first time in about 13 years that it has start to level off. Again, this looks at a trend. Things were going okay. Things are going over okay. And then the last couple of months, things start to level off. Now, this number, the total US household debt, I think it is a little deceiving because it includes mortgages. And so of course, since from 2013 to 2023, of course household debt has gone up a lot because the value of properties has increased so much. And so when anyone bought a house in the last 10 years, which is millions and millions and millions of people, their debt went up.
Now, their equity went up too, so that’s the good thing about it. And a lot of this, you could argue, is considered, quote, unquote, “good debt”. Remember, when we talk about debt, there is bad debt, which is basically used to finance your lifestyle. And this is just my objective opinionation. There’s no definition of good debt and bad debt. But to me, taking on debt to finance your lifestyle to buy things that you can’t afford and that have super high interest rates is not necessarily a good thing. Good debt is something that is used to fuel an investment, like a rental property. I think you can also argue that student debt for the right degree at the right college is also an investment in yourself. Those are things that we’re using debt to improve your financial situation in the long run. And when you look at this debt and that a lot of it is mortgage debt, you have to think that some of it, at least, is considered good debt.
It is obviously shocking to see this number really high. But I think to try and understand consumer behavior, we need to drill down into another indicator, which is credit card debt. Now, credit card debt is less commonly used as, quote, unquote, “good debt”. Of course, there are good reasons to take on credit card debt if you want to start a business or you need to fund your business. There’s all sorts of good reasons to do it. But generally speaking, a lot of credit card debt is bad debt. And so when we want to understand American consumer, I think this is an important indicator to look at. And what you see when you look at credit card debt is that is at an all time high. For the first time in Q2 of 2023, which is the last quarter I have data for, it topped $1 trillion for the first time.
And I think more concerningly, because that number, it’s just … These days, we throw trillions around, so 1 trillion might not sound like that much. But I think the more concerning thing if you look at the graph, which I will describe to you, is that it’s just pointing straight up. For the last six or seven months in a row, consumer debt has really been spiking. It was at about 750 billion, now went up to a trillion in just the course of six months, so that’s a 33% growth in just six months. That is a very rapid increase in credit card debt, something I have personally never seen data for. That is going to be another key indicator to watch, is that consumer and credit card debt is really high. Now, if you’re like me, when you see this and you see consumer household debt is high, credit card debt is super high, you’re like, “Oh my god, this is going to lead to a disaster.”
But lucky for you, I did some homework for you and tried to understand does this really matter. And what I found is actually super interesting. What I did was look at consumer debt and figure out how much people are paying on that debt on average and how much that is relative to their disposable income. Put that another way, of all the disposable income an average household has, how much money, what percentage of that are they putting towards their debt? And the answer is only about 5.8%, so that is actually really low. And so think about how this can happen. You might be curious. If debt is ballooning, how can people’s percentage that they’re paying towards that debt actually stay too low? And there’s two reasons. One is inflation. We’ve printed more money, so people have more money. That money is devalued, and so they might be paying this debt, but it actually is less of their total income.
The second reason is that interest rates are super low. So many people refinanced during the pandemic. And so out of all of that $17 trillion of debt, a lot of it is mortgage debt. And so people took out new mortgages at a lower interest rate. And so even though total debt is going up, their payments on that debt may have gone down. And so 5.8% of disposable income going towards debt service is higher than pre-pandemic levels. I should make that clear. But it’s marginally higher. It used to be about 5.6%. Now it’s at 5.8%. It is way lower than it was during the Great Financial Crisis. And it has actually flattened out. By that metric, even though debt has really risen for consumers, it’s not really affecting them day to day. This starts to explain why consumer spending might be so high. Now, I did two other things because I’m a nerd and I really was just curious about this, but I wanted to look at US consumer debt as a percentage of monetary supply and US GDP.
Let’s do those one by one. Monetary supply is just a fancy economic term for how much money is circulating in the economy. And if you’ve paid any attention over the last couple of years, you know that there was a lot of money printing during the pandemic, several trillion dollars. It grew at the fastest pace we have ever seen. And so that has its own concerns. That is an issue that … Of course, that’s not what we’re talking about today, but that is of course an issue. But when we talk about its relationship to debt, it is really important to note that it grew faster than total debt. And so the amount of US consumer debt as a relationship to the total amount of money in the US economy, it has actually gone down. Pre-pandemic US consumer debt to monetary supply was about one to … It was about 100%.
Now it is about 80%. It is rising, but it has gone down. And that’s what I’ve been talking about throughout this episode. When I say this debt, yeah, these numbers are huge, but as a percentage of all the money in the US economy, they’ve actually gone down. Now, when you do the same sort of equation with GDP, you see the same thing. When you compare consumer debt to the total output of the US economy, it is basically flat. It has remained almost entirely flat for the last 10 years, so that really hasn’t changed. And just to recap, I just want to make sure everyone understands what I’m saying here. Debt is going up. That is true. But when you look at debt relationship to the economy as a whole, it’s basically the same that it’s been for the last decade. When you look at debt as a percentage of the monetary supply, it’s actually down from where it was pre-pandemic.
And so this, to me, signals that yes, having a lot of debt is a big long-term problem, but it hasn’t really changed. That problem has existed. That existed for 10 years. And it hasn’t really changed over the last couple of years, even though the headlines suggest. And they’re accurate, the debt has gone up. But when you think about people and the country’s ability to pay that debt, that hasn’t really changed, even though it is a long-term problem. Now, to back up that claim that I’m making and this research that I did, I looked into delinquencies on debt. This is basically looking at there’s all this debt, the number is going up, are people actually paying their debt? And the answer is yes. We see that credit card debt, people are actually paying relatively similar to pre-pandemic levels. Auto loans are starting to tick up a little bit, but are still relatively low in historical terms.
And mortgages, which is the biggest batch of consumer debt, are still extremely low. We talk about this all the time on the show. But there’s just mortgage delinquencies are very low right now. Now, all this can change, and we’re going to talk about that in just a minute, but we’re just talking right now about what is happening today. And right now, delinquencies on all this debt is really low. Now, one thing that was worth noting out, the chart I’m looking at shows delinquencies on student debt, which obviously dropped to zero at 2020. It actually used to be the highest delinquency rate. It used to be about 12% of delinquencies on student debt, which is higher than any other debt category that I can find or that is tracked, and that has fallen back down to zero. Later in the episode when we talk about things that might shift the balance in the American consumers, student loan debt is definitely something that we need to talk about.
But again, as of right now, delinquencies are very low. Just to summarize my reading of the American consumer right now, consumer spending is up, but it’s starting to flatten out. Sentiment, on the other hand, which has been kind of stable, is starting to decline. We have record levels of debt, but as of right now, Americans are paying their debt as agreed. The question now becomes what is going to happen in the future? Is this situation going to stay the way it is? Or is there a potential that all of this debt and consumer spending might start to decline? The question becomes could there be a debt crisis? Could the labor market break? And could consumer sentiment start to decline and send GDP downward? I don’t know the answer to that, of course, but I will pose five questions to you that I think are important to thinking through what might happen.
Now, the number one question to me is will the labor market break? Now, when we talk about the labor market, there are many ways to measure the labor market. None of them are perfect. If you look at unemployment though, it is near historic lows, although it’s ticking up a little bit. Wages, which were outpaced by inflation for many years, have actually started to outpace inflation by just a tiny little bit for the last couple of months. When you look at labor force participation, it is really starting to rebound near pre-pandemic levels. And as of the last reading, job openings, there are more than 9.6 million job openings in the United States. Although there is no perfect way to measure the labor market, when you look at all these things together, it is surprisingly strong. I personally thought we would see more unemployment than we do right now.
And although we are starting to see some softening, I don’t think anyone would describe what we have right now at the end of October 2023 as a, quote, unquote, “broken labor market”. But many economists, many analysts I think rightfully are questioning whether the labor market will break in 2024. We have been tightening interest rates for about 18 months. And most academic research shows that it takes somewhere between six and 18 months for the impact of higher interest rates to ripple through the economy. Think about that for a second. That means that right now, 18 months after the first interest rate hike back in March of 2022, we are just now starting to feel the impact of that interest rate hike. And that means even if the Fed is done raising rates, that for the next 12, at least six, maybe 12 months, we are going to feel ripples from interest rate hikes that already happened six months ago, maybe even 12 months ago.
And a lot of analysts and economists believe that one of the ripples that are felt are increased unemployment. Now, you’ve probably heard a lot about layoffs, but those are highly localized in certain sectors, like tech. In many other industries, job growth is booming. And they’re not always good jobs. Some of them are low paying jobs. But just, again, if you look at the whole picture of the labor market, it is strong. But I think that is … To me, the number one question mark going into 2024 is will we see a significant uptick in unemployment? I think it’s inevitable that we’ll see it go up a little bit, maybe to 4%, 4.2%. But do we see it get to 5%, 6%? Those are the numbers that really start to weigh on consumer sentiment, consumer spending, and could really weigh on GDP.
That is my number one question. The number two question is will pandemic savings run out? Now, a lot of people talk about this, rightfully so, that when you look at consumer spending and the lack of debt delinquencies, is that there was a lot of stimulus during the pandemic. People also just … even if you … Regardless of stimulus, there was nothing to spend money on, so people saved a lot of money. And this is a really hard thing to track. I’ve seen many different studies, but one recent one actually from the Fed, the San Francisco Federal Reserve Board, said that they believe that the excess savings that people built up during COVID are likely to be depleted during the third quarter of 2023. The third quarter of 2023 just ended at the end of September. By the Fed’s own analysis, they think we’re going back to pre-pandemic levels of savings, which obviously could put downward pressure on consumer spending.
If people run through their savings, they obviously have less money to spend. And so that is a really big question. It seems most academic studies that I have seen suggest that they have run out or are about to run out. And so whether or not that has an impact on consumer spending, we’ll have to see, but you mean logic dictates that it probably would. The third question is student loan repayments. Now, 40 million Americans have student loans, and those were forebeared. Is that a word? They were in forbearance for almost, I think, maybe over three years. And as I just said earlier, that was one of the highest delinquency rates of any type of … It actually was the highest delinquency rate for any type of debt. And I hope that people don’t go delinquent on their student loans, but they don’t even need to be delinquent on them for it to impact the economy.
There are estimates that the average payment that is going to start being resumed this month in October is 300 to $400 per month. That is a lot of spending money. If you think about 40 million Americans spending $300 less per month on consumer goods or consumer services and putting that towards their debt service, that is a really big potential impact on the economy. And so that is one I’m definitely going to be watching really closely. The fourth is the geopolitical situation. Now, everyone who follows the news knows that we are in a very volatile situation with wars in Ukraine and Russia and a new one emerging in the Middle East. And I’m not smart enough to pretend to know how ongoing wars and all this international tension that is going on impacts American consumers. Honestly, I don’t know. But let’s just say that these types of tensions make the economy more volatile in general.
The whole world becomes a bit more volatile. And so we have to consider what happens with these geopolitical situations when we’re trying to forecast the economy in 2024. Now, again, I have no idea what’s going to happen there, but I just want everyone to think about that this could impact the US economy. The last one, number five, is a potential government shutdown. Now, we avoided one with a last minute extension, but that was just for 45 days, and there is still potential that there will be a government shutdown. Now, government shutdown doesn’t necessarily directly impact consumer spending or consumer behavior, but it does have a psychological effect on pretty much the whole country. And there are government employees and service members who will not be getting paid. And so those people not getting paid, these are millions of Americans, they obviously might tighten up their spending.
And so when I look at this situation, when I look at these five questions … Will the labor market break? Will pandemic savings run out? What happens with student loan repayment? What’s going on with geopolitical situation and a potential government shutdown? To me, I see a lot of potential risk in consumer sentiment and consumer behavior going down. Now, I don’t know if that’s going to happen, but to me, it looks, and a lot of the data suggests, like we may have peaked for this cycle. Guys, I’m not one of those people who thinks this is going to be a crash of all crashes and that that’s going to destroy the entire economy. But business cycles are normal. Recessions are normal parts of living in a capitalist market economy. And we might be at the peak of consumer spending, at least for now. Now, consumer spending peaking or going down a little bit doesn’t necessarily mean we’ll be in a technical recession.
There is no real technical definition of recession. It is a subjective evaluation by a bunch of people at the National Bureau of Economic Research. But remember, consumer spending is important. It is 70% of the US economy, but it is not the entire US economy, and it is possible that other parts of the economy make up for any potential downside. But I just wanted to give you guys my reading of the situation. Because consumer sentiment is such an important driver of the economy, I wanted all of you, all of our listeners, real estate investors, investors in other things, and just Americans in general, to understand what’s happening and some of the risks to the biggest driver of the American economy going into 2024.
Of course, this is just my reading. If you have different opinions, I would love to hear from you guys. You can find me on Instagram where I’m @TheDataDeli. I really enjoy debates about this. No one knows what’s going to happen, guys, but this is my reading of the data. And if you have a different one or have thoughts or questions, feel free to hit me up. Thank you all so much for listening to this episode of On The Market. I’ll see you guys next time.
On The Market was created by me, Dave Meyer, and Kaylin Bennett. The show is produced by Kaylin Bennett, with editing by Exodus Media. Copywriting is by Calico Content. And we want to extend a big thank you to everyone at BiggerPockets for making this show possible.