The Independent Market Observer

2/19/14 – Consumer Spending Trumps All: Minimum Wages and Borrowing

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Feb 19, 2014 8:05:36 AM

and tagged Commentary

Leave a comment

We have two interesting things to look at today: a report from the Congressional Budget Office on the effects of a higher minimum wage, and a report that consumer borrowing has ticked up as banks become more willing to lend.

Let’s look at the Congressional Budget Office report first. The CBO is a widely respected nonpartisan source for independent numbers on legislation—a referee, if you will. The typical CBO report provokes arguments from both sides, which suggests to me it’s usually pretty close to right.

This report is no exception, stating that a rise in the minimum wage will both cost jobs and lift a large number of people out of poverty. The executive summary is explicit about these effects, concluding that the net benefit will be positive but small. The report is already being spun by both sides, but let’s look at what it actually means.

The way the CBO did the analysis, income gains will go almost entirely to families making less than around $60,000–$70,000 per year, while the income losses—largely from small business owners—will come from families making more than $130,000 or so per year. Because the gain and loss numbers are almost equal, you can consider it an income transfer between higher-income families and lower-income families. Arguably, this is functionally equivalent to raising taxes on higher incomes while providing increased benefits to lower-income families, but to my mind, it’s a much preferable alternative, as the increased income comes only with actual work.

Here’s the problem. With minimal net economic benefit, in the form of increased spending, any argument to raise the minimum wage must be based on values (where people can reasonably differ) rather than on numbers (where they really can’t). So, from an economic point of view, despite the potential social effects and the press it’s getting and will continue to get, there will be no significant effects.

That’s not the case, potentially, for the second piece of interesting news today, the increase in consumer borrowing. For the first time since 2008, consumer borrowing rose on a year-to-year basis in the fourth quarter of 2013. The biggest bumps were in student loans, auto loans, and mortgages, with a relatively small increase in credit card debt.

If you think about this, it is encouraging. Going to college, purchasing a home, and even buying a car are long-term, necessary investments. Spending on these items lays the groundwork for future growth in savings and income, unlike most credit card debt, which goes on short-term consumption. Growth in mortgage borrowing was driven by a decline in foreclosures and write-offs, which is also encouraging.

The bigger picture is positive as well. Delinquency rates for all types of loans, except student loans, are down significantly and still declining. Lenders are becoming more willing to make loans, despite their own very real constraints, because they see the improvement in the financial situation of the average borrower. Debt service requirements also remain at multi-decade lows.

The economic effects of increasing consumer spending, especially on longer-term purchases like homes, cars, and education, can be significant. Unlike more short-term spending, this borrowing contributes to future benefits, such as higher incomes for the educated, home equity for homebuyers, and the multiplier effects that surround auto manufacturing and sales.

The increasing willingness of banks to lend, while consumers borrow, is also providing a cushion for the economy to make up for slow wage growth. Something to watch is whether wage growth will also accelerate and support the growing borrowing—but that’s not a problem just yet.

What we can take away from these two pieces of data is that the economy continues to grow, and the biggest piece of that growth, consumer spending, continues to increase in a way that is sustainable. Worries about the economic impact of a rise in the minimum wage do not appear supported, and the end of the consumer delevering cycle should also support further growth.


Subscribe via Email

New call-to-action
Crash-Test Investing

Hot Topics



New Call-to-action

Conversations

Archives

see all

Subscribe


Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®