Cracks in the Foundation

It is said that a building is only as strong as its foundation.  If we imagine a country’s economic output as a building, the foundation it would be built upon is that country’s consumer.  Consumer spending makes up over 50% of GDP in every major developed economy (69% in the US), so if consumer spending falters, OR if the money spent by that consumer fails to benefit the local economy in terms of jobs and productivity, then the building’s foundation weakens.


Over the past 5 or 6 years, consumers have been on a spending spree fuelled by low borrowing rates, which has provided a solid base for these GDP skyscrapers.  However, recent developments bring into question whether these are skyscrapers, or just a series of Jenga towers.


With wage inflation virtually non-existent, where has the money come from that consumers are throwing about?  Debt.  With interest rates near zero, the consumer has been borrowing, often from the equity in their homes, with what some would consider reckless abandon.  Servicing this debt at current interest rates has been manageable thus far, but we’re starting to see the consumer feel less wealthy as rates rise, and this is having an impact on the discretionary spending of the consumer.


Stores closures as a canary in the coal mine


Consumer spending is the aggregation of all private spending on durable goods, non-durable goods, and services.  One quarter of this spending is in the non-durables sector, which has been the dominion of the traditional retail store.  This is important as it results in job creation in the retail sector, which results in employment growth and additional consumers with discretionary income to spend in the local economy.   There has been a shift from bricks and mortar retail, to online retail, which seems to be reaching a tipping point of late. 


Retail store closures accelerating, but does that matter?


2017 saw a record number of store closures, with the US losing more than 5,000 retail stores.  This situation seems to be worsening as there have already been more than 1,000 store closures announced in the US in 2018, including Teavana, Gap, Sears, Sam’s Club, and Best Buy.  The UK saw headlines of brand name stores such as Toys ‘R Us and Maplins announcing that they have gone into receivership, while Tesco’s, Sainsbury’s, Marks & Spencer, Debenhams, and New Look have all announced job cuts as retail sales numbers continue to be eroded by online buying.


Some will argue that the bricks and mortar revenues are merely being replaced by online revenues, but that ignores the spin off effects of fewer local retail employees, which are not replaced one for one with employees of the distribution centres, and delivery staff.   According to a 2014 study by PricewaterhouseCoopers (“The Economic Impact of the U.S. Retail Industry”), the retail sector is the largest private employer in the United States. Retail directly and indirectly supports 42 million jobs, provides $1.6 trillion in labor income and contributes $2.6 trillion annually to U.S. GDP.  A decline in this sector will have an impact on employment and GDP.


The consumer has lots of money to spend, no?


Consumer spending in the US continues to be very strong, increasing 3.8% in the fourth quarter of 2017, with the average consumer spending over $57,000 annually, according to the Bureau of Labour Statistics.  That’s a big number in a country which had a median income level of $56,516 in the most recent US Census.  But what portion of consumer income goes to servicing debt? 



The amount of household debt in the US has been growing significantly of late.  In other economies like Canada and the UK, it is worryingly high.  With high levels of debt come high levels of debt servicing, and with interest rates set to rise further in all three of these countries, it is impossible to see how consumer spending will not be significantly impacted.





Author: John Glover


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