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U.S.: WILL CONSUMERS SAVE THE DAY? KEEP YOUR FINGERS CROSSEDConfidence is dropping, but spending may stay healthy a while longerHousehold America has been riding high. Since early last year, consumer spending has grown more than at any time since the boom years of the early 1980s. In fact, households have accounted for more than twice the economic growth that capital spending has contributed. But now, as tighter financial conditions and weaker global demand hammer the business sector, the pressure is on households to keep on spending. If this 7 1/2-year expansion loses consumers, a recession will be difficult to avoid. Will consumers save the day? So far, the pluses outweigh the minuses. But the negatives are growing. Households' confidence in the future plunged in October. But at the same time, consumers noted only small deterioration in their current situations, and weekly surveys of October retail activity suggest buying is brisk. True, layoff announcements are up, but weekly jobless claims in October do not show a sharp break from their recent trend (chart). Although a credit squeeze is pinching Wall Street financing activity, banks seem more than willing to lend to households. Banks have tightened their lending standards, especially for some large companies, but bank credit is still flowing smoothly. And with the Federal Reserve cutting interest rates, which lowers banks' cost of funds, banks will keep competing for new borrowers, with obvious benefits for housing and rate-sensitive consumer goods. In fact, another wave of mortgage refinancing--even larger than the one earlier this year--is set to support outlays in coming months, perhaps in time for holiday shopping. MAKE NO MISTAKE, consumer spending is going to slow by some degree. That's because the two major forces that have propelled household outlays--strong job markets and richly accommodative financial conditions--are both starting to wane. Increased wealth from stock-market gains and a surge in mortgage refinancing because of low interest rates have lifted both consumer spending and housing far above levels that fundamentals would have suggested. So far this year, for instance, real consumer outlays have grown at an annual rate of 5.4%, but real income is up only 3.5%. And home sales hit records this summer, even though demographics could not justify such a high level of new housing. Now, reality is setting in. Consumers are growing more concerned about their economic futures. The Conference Board's index of consumer confidence in October fell to the lowest level in nearly two years. The index has now declined for four consecutive months, and the slide in the past two months has been the steepest since the economy was struggling to recover from the recession in 1991. In its report, the Board said that overall confidence remains lofty by historical standards, held up by a lower but still high assessment of present conditions. However, it noted that consumer expectations have deteriorated sharply, to levels typically associated with a sluggish economy (chart). The Board attributed the downbeat attitudes to financial-market turmoil, political concerns, and layoff announcements. The big worry: If confidence falls further in coming months, the holiday buying season may suffer immensely. HOMEBUILDERS WILL ALSO FEEL the chill of a consumer slowdown. However, the pace of housing activity has been unsustainably high, so a drop-off in demand was likely even without the recent financial turmoil. After all, a record 66.8% of Americans already are homeowners. In addition, demographic trends mean that fewer adults are moving out of their parents' houses and going out on their own, so demand for new housing is slowing down. That doesn't mean housing will collapse. But the sector is unlikely to add to economic growth as it did in the first half, when residential construction, although only 4% of the economy, accounted for 13.5% of the increase in real gross domestic product. Already, the data are mixed, usually a sign that a sector has hit a turning point. Mortgage applications to buy a home, for example, skyrocketed by 41% from mid-August to the first week in October. Applications pulled back somewhat in the following two weeks but remain high. However, the tally of actual home sales is slipping. Existing homes sold at an annual rate of 4.68 million in September, down 1.1% from the August rate, which was down from July's sales pace. The surge in mortgage applications--as well as the still strong weekly reports from stores--point up one contradiction in the confidence survey. Consumers may say they're worried about the economy in general. But as long as most individuals are not worried about losing their own job, then overall spending does not suffer much. Keep in mind, though, that workers have not forgotten the early years of this expansion, when job jitters kept a tight rein on consumer spending. Any downturn in the labor markets could quickly cause consumers to table future buying plans. THAT'S WHY THE BIGGEST RISK in the consumer outlook is not Wall Street's gyrations, per se. After all, most household investments are tied up in 401(k) plans, and most consumers are not retiring soon. The biggest risk is how Corporate America deals with its new challenges in the wake of the Street's turmoil. Without a doubt, the tightening of domestic financial conditions since the summer is going to hit the corporate sector hard, even as global weakness is already weighing heavily, especially on manufacturers. As 1999 approaches, many businesses are looking at a combination of weak profits, costlier credit, and more expensive equity financing, all on top of slower economic growth. Clearly, something has to give. The first cuts on the list will most likely be capital spending, but not yet. A big part of the surprisingly strong 0.9% rise in overall durable-goods orders in September came from increased demand for capital equipment (chart). However, the fundamental supports under business investment in new buildings and equipment are the poorest in many years. Facing leaner 1999 budgets, many companies may be squeezing every drop out of their 1998 appropriations. Moreover, at some point as demand slows, businesses will start to cut hiring, and household income growth will weaken at a time when the wealth effect is waning and the consumer saving rate is essentially zero. That will increase the incentive to save and decrease the urge to splurge. The big question, of course, is: How much will Household America pull back? The best indicator of that will be the labor markets. So far, the job data don't suggest that businesses are lopping payrolls at an alarming rate. But if job growth slows to a standstill, consumers will be in no position to rescue this economy.
By JAMES C. COOPER & KATHLEEN MADIGAN RELATED ITEMS
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Updated Oct. 29, 1998 by bwwebmaster
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