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My view on what's going on in the financial markets and the global economy, and a few other things that might interest me from time to time.

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Guns or butter?

How many of you that were economic or business majors at university remember the discussion in introductory macroeconomics about “guns & butter”, references to defense spending versus domestic spending? This economic topic illustrates the simple fact that every country in the world must make decisions as to how to allocate their budget, which is constrained by (the total of) tax revenues and external borrowing. Deciding how much to spend on various programs each year is a difficult, complex, and often a contentious process for politicians, just as we are seeing now in Congress regarding the current 2023-24 budget discussions. The simple fact is that governments do not have unlimited resources, and difficult choices must be made that best reflect the direction of the country.

This article could easily be about the ongoing angst in Washington as a dysfunctional US Congress tries to agree a new budget and avoid a government shutdown. As juicy as this topic is now, I am going to save it for another day because I want to use this analogy instead on the US consumer. Like the government appropriation process in many respects, US consumers must make spending decisions because they have limited means. (I am ignoring the small percentage of people for which money is no object, because they can be as smart – or as stupid – with their money as they wish, with limited repercussions.) This short article is about the consumer, an important topic for microeconomic theory and especially relevant at this point of the cycle.

Consumer decision-making

Most of us must constantly make decisions about where to spend our limited income and allocate our wealth, and this inevitably involves trade-offs. With respect to spending, a person might ask:

  • Should I consume a particular good or service now, or should I defer consumption and save the money for the future instead (assuming one can afford to do so)?

  • If I wish to consume now, how do I make decisions on allocation? With respect to food for example, do I spend more for better quality (e.g. lobster or filet mignon), or do I spend less and accept (arguably) lower quality (e.g. hamburger or chicken)? Or do I travel domestically and / or stay closer to my home, or do I travel further to more posh locations, or even abroad?

This thought process is microeconomics 101 at its core, and it is currently topical and a very important determinant of where the US economy might be heading.

The consumer drives the US economy (and most others)

Consumer spending accounted for 68.3% of GDP in the US in 2Q2023 (source: Bureau of Economic Analysis), so it is clearly influential in driving economic growth. Consumer choices can be expressed conceptually via graphs and so forth, but one of the key drivers – sentiment – is difficult to depict with accuracy or to generalize at all. What is clear is that consumer spending preferences are influenced by short-run factors like

  • Level of income,

  • The cost of servicing household debt (i.e., mortgages, auto loans, student loans, etc.)

  • The cost of goods and services,

  • The ability / willingness to substitute between products,

  • The marginal utility of one more unit of consumption (i.e., how much more do I really need?), and

  • Consumer confidence about the future.

Simply put, consumer behavior is a complex topic.

This article is focused mainly on the US. However, most G7 economies are not in a terribly different position as far as the importance of the consumer, even if consumer spending is generally a slightly less significant driver of GDP growth as you can see in this table.

What is arguably more important is the trend in personal expenditures rather than the absolute level.

Savings stock and trends

Consumers have been gradually dipping into their stock of savings, working down their pandemic “bonanza” since late 2021 / early 2022 in most developed economies as the graph below from the Federal Reserve illustrates (source here).

Perhaps not surprisingly, as the stock of savings has been declining in the US, the savings rate has also been declining as you can see in the graph below from FRED. The savings rate fell below and has remained below the level prior to the pandemic since late 2021.

It’s this simple – people feel poorer for many reasons, and one of the main culprits is inflation. Inflation means that the same amount of goods and services account for an increasingly higher percentage of consumers’ disposable incomes (assuming that wage inflation is not keeping up with general inflation). Therefore, consumers have a narrower range of available decisions regarding consumption that they can make today. If you couple pressure on consumer spending with tighter credit availability from banks and other lending institutions, it is highly likely that the US economy will slow too in the quarters ahead. Other headwinds include higher oi prices, the resumption of student loan payments, and higher borrowing costs, none of which are positive for the US consumer.

How about that 2023 recession?

Predicting a recession this year (2023) was a narrative that many analysts and economists embraced last year at this time. So far, they have been proven very wrong. As a result, risk assets have outperformed. Analyst after analyst has chased market levels higher, rushing to revise their year-end targets for stocks accordingly. This is the behavior of a herd, not the topic for this article, but a good one for the future because it is so blatant.

I am just one more pundit playing the guessing game of where economies might be heading. Like many Street analysts, I had expected a recession in the US in 2023 but in the second half of this year, simply because I thought tighter monetary policy would bite hard following the requisite lag. I shared my views openly in my year-end forecasts that I released in early January (here). Just like the Street, I will almost certainly be wrong, too, making me just one more member of the herd. However, unlike many Street firms that are embracing the soft-landing scenario which means avoiding a recession all together, my instinct is that the US jobs market will start to crack as consumers rein in their horns.

The 2024 slowdown is coming

Keep in mind that nearly all the economic data monitored by investors is backward looking. Looking into the rear-view mirror provides a wonderful view but is not necessarily reflective of the reality that might lay ahead. Of course, a recession narrative is at odds with the Federal Reserve’s economic projections (to be updated today FYI), and I doubt seriously that I know more than the Fed. However, the effect of slowing consumer spending on the economy seems logical, even plausible, given the backdrop.

Monetary (and fiscal) policy operates with lags which are imperfect and hard to predict. The “Goldilocks scenario” of the US economy on a glideslope towards lower inflation accompanied by a resilient jobs market simply will not likely persist as the lagged effects of monetary policy begin to bite. I believe that there will be a sharp economic slowdown in the US next year, and this could easily lead to a recession. Early signs suggest that consumers might be thinking the same and are beginning to adjust their behavior accordingly, even if it is not consciously.


At the end of the day, you can’t have both guns and butter – difficult choices will increasingly dampen consumer demand, and this has knock-on effects into jobs, and ultimately, investment assets like stocks and bonds. I expect bonds to rally at some point, while stocks remain under increasing pressure…. that is, if I am right. It’s 50/50 I suppose. And like the Street, I can always change my mind to fit the reality.


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