Data announced this week reveals the scale of the economic toll exacted by the COVID-19 restrictions. The data makes for harrowing reading, but the information is backwards looking. It does not fully capture the reality that in the present quarter economies across the world are reopening at a higher pace than many expected.
To give a more representative picture, we delve deeper into the impact of the virus by examining two critical components of all advanced economies; consumption and savings.
Consumption and COVID
The fortunes of most advanced, developed economies are heavily influenced by levels of household spending. According to the Organisation for Economic Cooperation and Development household consumption is the amount of final expenditure made by the resident households of an economy to meet their everyday needs, including food, clothing, leisure, energy and transport.
Healthy household consumption is vital to the strength of all advanced economies, as revealed by any cursory search. For instance, 66% of the value of UK Gross Domestic Product (GDP) can be accounted for by household consumption. The percentages are equally robust for the Euro Area and the US at 54% and 68% respectively.
We have written before about the demand destruction caused by COVID-19, as economic lockdowns reduced the need for spending on items, such as transport fuels. Furthermore, restrictions imposed impacted the ability of consumers to purchases goods and services for pleasure. While recent datapoints indicate tentative signs of recovery, overall consumption is still some way below pre-pandemic levels.
Savings and COVID
Taking all the above into consideration what has happened to the money that under normal conditions would have been used to purchase goods and services over the last few months?
The graph below gives us the answer. Graph 1 shows how UK savings, relative to disposable income, ballooned during the second quarter of 2020, rising from 5.4% at the start of the year to a projected level of 21%. Once again, the word ‘unprecedented ‘comes into play.
Graph 1: UK Household Savings Ratio (Q2 2020 – Projected)
Source: Office for National Statistics, data as of July 2020
Other economies are also experiencing the same phenomenon. According to the US Bureau of Economic Analysis, the US savings rate hit a record 33% in April, before falling back to a still buoyant rate of 23% as various US states began to reopen at a faster rate than witnessed in other countries. The surging rate observed during 2020 is even more remarkable when placed into context over the longer-term: between 1959 and 2019, the average personal savings rate for the US was 8.9%.
Moreover, while the percentage figures outlined by Graph 1 are dramatic, Graph 2 shows the monthly change in monetary terms. All told, UK households stashed away almost £55 billion during the second quarter, during a period when the Bank of England’s base rate yields a miserly 0.1%! The ability to earn an income, or ‘economic rent’, from bank deposits is sadly at an end. With inflation subdued but lurking it isn’t surprising that savers are looking for alternative routes to preserve wealth and is rational behaviour.
Graph 2: Value of Monthly change in UK Household deposits (Billions of GBP)
Source: Bank of England, data as of 30 June 2020
For policymakers who examine and need to understand the motivation behind the vast jump in household saving rates, there are two equally plausible interpretations of the data under consideration:
1) involuntary saving
2) precautionary saving
Determining the exact balance between both matters a lot because the implications for further future policy are profound.
For instance, if, on balance, most of the build-up in consumer spending is involuntary, and a wave of currently confined consumer spending is released, further extensive stimulus could lead to rising inflation. Increasing inflation could derail future capacity to borrow. Conversely, if consumers remain over-cautious and spending subdued, sizeable additional stimulus measures will be needed to combat economic uncertainty and provide support to company profitability and, ultimately, employment levels.
While consumption rates (and therefore the overall fortunes of national economies) depend on the successful suppression of the virus and underlying economic strength, the experience of countries in the Far-East hint at which of the two possibilities outlined above is most likely to manifest.
Surveys by the World Economic Forum indicate economies moving further along the COVID-19 recovery curve see uncertainty recede. Respondents become more optimistic about their respective countries’ economic fortunes, and in turn, spending becomes buoyant. In other words, the classic correlation between consumer sentiment and respondents’ desire to spend is evident.
In China, respondents are further along the curve and more optimistic about the economic outlook. Consequently, the relationship between household optimism and increased propensity to spend became manifest during the second quarter, with the economy returning growth of 3.2%.
In conclusion, no one can be certain that events in the Far East represent a sign of things to come for Europe and the US. Regrettably, the threat of a second wave clouds the outlook for both regions. Still, if Western governments institute policies to restrict any rebound in the R rate, the experience from the East offers a glimmer of confidence. Spending will resume, serving to bolster overall consumption and economic growth.
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