As the consumer goes, so goes the economy." That's the thumping
refrain that most economists and financial gurus overwhelm us with
every time the economy dives into a funk.
Divining consumer spending for insight into the direction of the
economy appears plausible: Personal consumption expenditures doe,
after all, account for 70 percent of gross domestic product. No
wonder, then, so many professional investors graph the trend in
monthly same-store sales at
, fret when
Home Depot (
misses a quarterly revenue estimate, or wonder if
is selling fewer F-150s.
But this focus on the consumer and his spending habits is
misplaced. The fact is, consumer spending trends consistently
higher for the most part, and has been trending consistently higher
since the second quarter of 2009.
The above graph raises an obvious question: If consumer spending
has recovered why hasn't the economy recovered? The question is
legitimate; we've been inculcated on the precept that economic
lethargy reflects consumer lethargy, but consumers are obviously
Unbeknownst to many investors, economic activity extends far beyond
final consumption. When gross domestic product is calculated, the
statisticians at the BEA purposefully focus on final consumption to
avoid double-counting. That's not the most accurate measure of
economic activity though.
Financier Mark Skousen developed a technique that I find helpful
for developing a more inclusive picture of the economy: he adjusts
GDP to include business spending. By Skousen's calculations, based
on sales receipts and gross business receipts compiled by the IRS,
consumption represents only about 30 percent of total spending,
while business investment (including intermediate output) accounts
for over 50 percent.
GDP growth estimates have been revised downward a few times over
the past two years, and I've long suspected weak business
investment was the cause. Private business investment, which has
only recently begun to show signs of life, remains far off the rate
of private investment before the start of the 2008-2009 recession.
In short, the economy continues to struggle not because of a
decline in consumer spending nor because of a lack of government
spending (which has also increased) but because a very important
driver of economic growth - private business investment - remains
This concept of business investment driving the economy runs
counter to much of what we read in media accounts and what we are
taught in college. But the fact that business drives consumption
and economic growth is a concept French economist Jean-Baptiste Say
forwarded 200 years ago.
Say's law is simple and logical - production drives consumption. It
can't be any other way. You can't demand what doesn't exist. A
hundred years ago, no one demanded a
jetliner; 10 years ago, no one demanded an
iPhone. Entrepreneurs and businesses create demand and drive the
economy forward by developing these products; additional production
can be undertaken only by increasing capital investment today, thus
increasing consumption and economic growth tomorrow.
Because all consumption is predated by production, I keep a close
eye on private investment, new capital expenditures (as opposed to
maintenance expenditures, which simply maintain the status quo),
The good news is that pockets of strong private fixed investment
and growth persist: namely in information technology and in
computer and peripheral equipment. I'll be more convinced of the
sustainably of a long-term recovery if I see more private
investment in sectors where business investment has been weak:
manufacturing, transportation equipment, and beleaguered
residential real estate.
So, keep a close eye on business investing, because production and
investment leads us into and out of recessions, and a farther eye
on consumer spending.