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Commentary: Oil Prices Won't Spook Consumers...


Here we go again. Every time oil prices rise a lot, fears about consumers shoot up like gushers. If families have to shell out more for gasoline and heating oil, they won't have money to buy other items, the argument goes. And a fall in consumer spending, moreover, pushes the economy into a sharp slowdown.

But hold on a minute. Yes, sticker shock at the pump hurts, especially for moderate- and low-income families who spend a larger share of their budgets on gasoline. And now that natural gas prices are following oil's upward climb, heating bills could be painful this winter, especially if frigid weather comes early.

Still, consumers have a lot going for them, and these positives should outweigh the drag coming from high energy costs. Jobs and incomes are growing at solid, albeit not spectacular, rates; wealth is at a record high; and interest rates, including mortgage rates, remain near all-time lows.

What's more, even with oil and gas prices soaring, energy takes a smaller bite out of household budgets than it used to, thanks to better home insulation and cars that are more fuel-efficient. During the oil shock of 1979-80, 6% of the average household budget was spent on energy goods from gasoline to heating oil. Now the share is less than 3%.

But didn't high gas prices cause the soft patch in the second quarter, when growth of consumer spending slowed dramatically? Only in part. True, high energy costs left less money to spend on other items. But an equally important reason for the spring slowdown was a drop in vehicle sales after auto makers removed many incentives. Now the deals are back and so are car sales. Household spending is on track to grow by at least 3.5% in the third quarter. In other words, consumers still managed to shop at a robust clip, even when gas averaged $1.85 a gallon for the quarter. The economy probably grew at close to 4% in the third quarter, after a 3.3% advance in the second.

Look to employment growth to explain the rebound. So far in 2004, hiring has averaged 180,000 per month. That's not gangbusters, but it has been good enough to raise labor compensation by 4 1/2% in the past year. And the gains in salaries come at a time when other sources of income are increasing rapidly. Both dividends and the income of owner-operated businesses have increased by almost 7% during the past year.

Besides income, consumers have two other supports to spending. First, according to Federal Reserve data, household wealth rose to a record $46 trillion in the second quarter. Granted, the distribution of financial assets in the U.S. is highly tilted toward the already wealthy. But some inroads have been made. Today, a majority of households owns stock, and a record 68% own their own homes, so more households are benefiting from rising home and stock values.

Second, consumers can still borrow. Although the Fed is hiking short-term interest rates, the bond market has pushed long-term yields down. Mortgage refinancings have increased for four weeks in a row. And thanks to past refis, consumers are not drowning in IOUs. The Fed reports that debt servicing in the second quarter took up 13.1% of income, essentially unchanged from last year's 13.2%.

The biggest danger for consumers from high energy prices is that they will cause businesses to cut back on their other expenses, namely labor. If hiring turns south, then it will be time to worry about consumers. That doesn't look to be the case now. When the Labor Dept. reports on September payrolls on Oct. 8, the data could be skewed by Hurricanes Frances and Ivan. Nevertheless, economists expect the gain to be 175,000, on par with this year's average.

Barring a collapse in the job market, consumers will prove their mettle. They've done it many times before. Just look at what happened after the terrorist attacks of 2001. Economists worried that consumers would avoid public places like stores and that their retrenchment would trigger a deep recession. Instead, auto makers slapped on 0% financing, and bargain-hunters came out to shop. Consumer spending in the fourth quarter grew at a 7% annual rate, the most in 15 years. The lesson: No matter what the adversity, never count out the American consumer.

By Kathleen Madigan


Silicon Valley State of Mind
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