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U.S.: Will There Be a Second Dip in the Recession?


The Commerce Dept.'s Jan. 30 report on real gross domestic product will most likely show that the U.S. economy contracted at an annual rate in the neighborhood of 1% in the fourth quarter despite a surge in real consumer spending of about 4%. Since a lot of that boost came from an unsustainable jump in car buying, a fallback in consumer outlays is occurring this quarter. Will the drop be a one-shot deal or could a continued consumer retrenchment extend this recession?

Don't worry. Consumers are not going to lead the U.S. into a double-dip recession or prevent a recovery from taking hold. Certainly, there are risks, but the favorable fundamentals underlying spending argue that households will remain resilient in 2002.

The double-dip scenario goes like this: After dropping in the final two quarters of 2001, real gross domestic product will manage a gain this quarter, thanks to inventory rebuilding. But further weakness in consumer spending will cause the economy to relapse. Consumers will be cowed for several reasons. First, lucrative incentives stole car sales from 2002. Second, labor markets and wage growth will weaken further. Third, two recent props under consumer spending will fall away: mortgage refinancings and cheaper energy. And last, with savings low, consumers will be crushed by their debt loads.

THESE WORRIES, HOWEVER, don't tell the whole story. Households have, for the most part, shrugged off terrorism, layoff announcements, and the scandal at Enron Corp. Optimism is the highest in a year (chart), and consumers keep shopping. True, the reversal in car buying will affect first-quarter data. Vehicle sales, which averaged a record 18.4 million annual rate in the fourth quarter, may not top 15 million this quarter. That decline will probably cause overall consumer spending to post the first quarterly drop in a decade.

But households are buying more than just cars. Retail sales excluding cars and gasoline rose from October through December (chart). Discounting moved much of the merchandise, but the steady uptrend shows that consumers are willing to shop, especially for household-related goods. December sales at furniture and electronic stores were up nearly 10% from a year ago.

The second double-dip worry--further deterioration of the job market--is always a risk for consumers. But falling weekly jobless claims strongly suggest that the worst job news is over. The consensus view of economists surveyed by Standard & Poor's MMS is that nonfarm payrolls fell by only 60,000 in January. That would be the fewest layoffs since August.

True, the increased ability of U.S. companies to generate output from productivity gains suggests that layoffs will continue after the recovery starts. But as Federal Reserve Chairman Alan Greenspan pointed out in a Jan. 11 speech, as productivity strengthens, "average real incomes could rise, at least partially offsetting losses of purchasing power that stem from diminished levels of employment." Unemployment is devastating to those directly affected, but better productivity will help to boost real pay for the 94% of the labor force that still has jobs.

Nor does the dissipation of mortgage refinancing or cheaper fuel spell disaster in 2002. Refis cut monthly payments or enable people to cash out some of the equity built up in their homes. Greenspan said the cash-outs alone totaled "roughly $75 billion" at an annual rate in the third quarter of 2001. In addition, he estimated that lower fuel costs "added more than $50 billion, at an annual rate, to household purchasing power in the second half of last year."

Mortgage rates and fuel costs stopped falling at the end of last year, but the windfall from both supports is still working its way through the economy. Energy prices have not risen from a year ago, so consumers can still heat their homes and fill their tanks more cheaply than in the winter of 2001. And homeowners who refinanced are still paying lower monthly mortgage costs than they used to.

INDEED, CONSUMER FINANCES are in better shape than they were in early 2001. A major misconception in recent years is that sinking stock prices, crushing debt burdens, and skimpy savings have robbed many households of any ability to cope with the downdraft of a recession. But that's overstating the case.

To be sure, eroding stock wealth is still taking a toll on consumer spending, and the impact will continue this year. Only about a third of households, however, own stock directly, while more than two-thirds own their homes. Since the first quarter of 2000, the value of corporate stocks and mutual funds directly held by households has declined by $4.8 trillion, based on Fed data on household balance sheets. But at the same time, house values have risen $1.8 trillion, while mortgage debt increased by $700 billion. That gave homeowners a $1.1 trillion net gain in the value of most consumers' biggest asset--a nice offset to any stock losses (chart).

The recent performance of property values is in sharp contrast to the previous recession. During 1990 and 1991, housing net worth fell $200 billion. Homebuilding activity will contribute little to the coming recovery because it didn't fall off during the recession. However, housing's more important contribution may well be its lift to household balance sheets.

CONSUMERS HAVE ALSO taken advantage of low interest rates to manage their debt burdens. In fact, revolving installment debt peaked in June, and the decline since then is a record. Households are using tax refunds and lower financing costs to pay down their debts. Debt-service payments for nonmortgage debt fell in the third quarter, the first drop in a decade.

No doubt some households are hurting financially right now. Delinquency rates for auto loans, personal loans, bank-card debt, and home mortgages all are up from a year ago. This, however, is typical recession behavior, suggesting no unusual structural problems.

Finally, the problem of low household savings is overblown. The Commerce Dept. defines savings as income that is not spent. Except for the boost generated by the tax rebates, the saving rate held at a puny 1% last year, down sharply from about 8% in 1990. But income from realized capital gains, a growing source of cash in the past decade, is not included in that measure. If it were, some economists have estimated the current saving rate is upwards of 8%, down little from about 10% in 1990. That level of savings should provide a healthy cushion for consumers.

Certainly, dangers remain in the consumer outlook. The uncertainty of terrorism, the spillover effects of bankruptcies at Enron Corp. (ENE) and Kmart Corp. (KM), and another stock-market swoon are potential pitfalls. But in 2001, U.S. consumers were resilient despite great obstacles. Nothing suggests they will cut and run in 2002. By James C. Cooper & Kathleen Madigan


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