Consumer Spending Still Has Legs


By Margaret Popper Achieving a recovery is a bit like winning a relay race. Each team member has to do its bit to get the economy moving smartly, generating enough growth to create jobs. Three runners are on this team: The Federal Reserve, whose job is to stimulate economic growth by cutting interest rates; the consumer, who's supposed to buy stuff using the easy credit that low interest rates create; and business, which needs to use the same cheap financing to make big investments in plant and equipment.

So far in this cycle, depressed earnings have kept business on the sidelines with a sprained ankle, leaving its teammates to pick up the slack. The Fed certainly did its bit by cutting key short-term rates by 4 1/4 percentage points during 2001 to end the year at a 41-year low of 1.75%. But in 2002, the race has been left to consumers. Many anxious economy-watchers wonder whether their spending will have an additional burst of energy that's big enough to keep the U.S. on pace for a reasonable 2003 recovery until business spending can get up to speed again.

ENOUGH STAMINA. Barring unforeseen shocks, consumer spending ought to be able to hang in there for the next quarter or two. Evidence is growing that business may soon pick up its spending pace. Until then, a renewed mortgage-refinancing boom should help keep consumers flush. And wages are continuing to climb, even though they aren't growing as fast as, say, two years ago. Although consumers' wealth has taken a beating at the hands of the stock market, they've seen the values of their homes rise and hold. Just as important, the Fed most likely would cut rates again before letting further market losses sap consumer demand.

But it's not a given that everything will go smoothly. Some potential risks to this scenario could prove insurmountable, among them a protracted war in Iraq, skyrocketing oil prices, a dramatic spike in unemployment, or a sudden meltdown in the housing market. But it would take a sustained crisis to hobble Americans' spending. "In the past, the consumer has collapsed only after shocks," writes Tobias Levkovich, chief U.S. equity strategist at Salomon Smith Barney, in a Sept. 6 research report.

Housing is the main support of the public's buying. Those who fear a residential real estate bubble may be comforted by the fact that even with home prices appreciating 1.6% in August over July, annualized new-home sales rose 1.9% during the same period. Demand for real estate isn't falling off. That's partly because mortgage rates are approaching record lows. A 30-year fixed mortgage is below 6%, a level not seen in nearly half a century. As a result, even more than in 2001, consumers are refinancing existing mortgages.

RELEASING MORE BUYING. The big question is whether they're using cash from the refis to lower debt or to spend more. Some economists argue that refis could add a total of $100 billion or more to consumer spending. Others say people are using the money to pay off expensive credit-card debt and get their household balance sheets in order.

Reality probably lies somewhere in between. "There are two kinds of consumers: People who plan their spending in a rational manner around the total amount of wealth they expect to accumulate in their lifetimes, and those who live hand-to-mouth, spending whatever they can," observes Ethan Harris, Lehman Brothers co-chief economist.

Given that the current refi boom is almost twice as big as last fall's, it's likely that a big chunk of change will be injected into the economy as increased spending. Lehman estimates that such spending could add a half percentage point of growth to 2002's third and fourth quarters.

RISING WAGES. Nearly as important to spending are wage gains. Although they haven't been stellar in 2002, they've held up well enough to support consumer spending. Perhaps the best measure of wage growth is the employment-cost index tracked by the U.S. Bureau of Labor Statistics. Overall compensation -- including salaries and benefits -- rose steadily, by about 1 percentage point a quarter, from September, 2000, to June, 2002.

Most economists estimate that wage growth will average 3% to 3.5% for 2002. Subtract inflation of around 1.6%, and that's a real income increase of as much as 2%. And that can fuel spending. Economists are hopeful that the trend will continue into 2003.

One big fear is that unemployment will rise again and take more out of consumer pocketbooks than wage gains are putting into them. It's likely that joblessness will jump from the 5.7% level recorded in August. But even if it ticks up to 6% in coming months, it wouldn't hit consumer spending that hard.

MORE SAVINGS? In his Sept. 6 report, Salomon Smith Barney's Levkovich says businesses' hiring intentions haven't declined recently, based on data from temporary-employment agency Manpower, which conducts a quarterly survey of 16,000 companies. "When the Manpower survey turns more positive, hiring actually improves," writes Levkovich. He's optimistic enough about the jobs outlook to project consumer-spending growth of 2.7% in 2003, before inflation.

Yet, continued stock market turmoil could be the shock that finally trips up consumer spending, some economists say. As people see their wealth keep evaporating, they'll start saving again. "The household savings rate of around 3% of disposable income is going to rise," says Goldman Sachs chief economist Bill Dudley.

Still, it would take a big stock crash to cause a significant jump in savings. Its last big hike was right after September 11, when the rate almost doubled to its current level. But it hasn't moved much since then. And even if stocks collapsed, the Fed would likely cut rates again to ensure that consumers kept spending.

A FEW MORE LAPS. That two Fed policymakers protested the decision not to cut rates at the Sept. 24 Federal Open Market Committee meeting gives some credence to the idea that central bankers may be mulling another rate cut. "To the extent there's further slippage in the markets that undermines economic activity, erodes wealth, and generally makes people more cautious, it wouldn't surprise me if the Fed takes out some insurance [in the form of a further rate cut] to make sure the recovery doesn't falter," observes Richard Berner, Morgan Stanley's chief U.S. economist.

Anyway, the latest signs of recuperation in the business sector may obviate the need for Fed action. Durable-goods orders fell just 0.6% in August, after a leap of 8.6% in July. August orders were still up 4.1% over the previous year. Inventories are so low that businesses are starting to add to them. Outside the tech sector, the levels of inventories to sales are at their lowest in 10 years. Even tech companies are nearing decade lows.

If this trend continues, consumer spending has to carry the economic baton only for a few more laps. By early 2003, business spending may take over. Popper is a senior contributing economics editor for BusinessWeek in New York


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