American consumers have always been a resilient bunch in the face of adversity, but last year was just too much to handle. They can be excused for bailing out amid $4 gasoline, plummeting home prices, and fears of another Great Depression. A year later, however, households are once again doing what they do best. They are spending—cautiously, but with enough punch to keep the economy moving forward.
The road ahead for consumers will be hard, yet the recent upturn in their spending is both encouraging and surprising. Outlays adjusted for inflation and excluding autos grew at a 2.6% annual rate from May through October. That's not too shabby considering weak labor markets, bombed-out household balance sheets, and damaged confidence. Plus, given solid gains in both September and October, non-auto outlays are on track to rise faster this quarter than they did last quarter.
The momentum is most evident in spending for services, which account for two-thirds of all consumer outlays. Over the past three months, inflation-adjusted spending on everything from housing to health care to recreation has grown at the fastest pace in more than two years. As a result, despite the sharp drop-off in car sales as the cash-for-clunkers program ended, overall consumer spending this quarter is set to contribute positively to economic growth for the second quarter in a row, something that seemed doubtful only a couple of months ago.
The key factor accounting for the resilience: Job losses are diminishing, allowing income from wages and salaries to stabilize, while non-wage earnings from rents, assets, and small proprietorships have grown. The government's October report on personal income included significant upward revisions from April through September. The numbers now show overall income rose at a 3.3% annual rate in the second quarter and 1.3% in the third, up sharply from the originally reported 0.6% and -0.5%, respectively, including a sizable upward refiguring of labor income.
The healthier picture of households also includes greater savings. Over the past three months, consumers saved an average of 4.3% of their aftertax income, more than a percentage point higher than previous data had shown and up from a record low 1% a year and a half ago. At the same time, the stock market rally and the stabilization in home prices suggests that households have now regained about a third of the $14 trillion in net worth they had lost since the third quarter of 2007.
These trends show that, despite still-heavy debt, consumers are making at least slow progress in repairing their financial positions. Moveover, balance-sheet repair is not preventing consumers from contributing to the recovery. In fact, the pickup in non-auto spending in recent months has occurred even as the volume of household revolving credit has shrunk at about a 10% annual rate.
Consumer spending will stay on track only with help from the job markets, and the recent trend in weekly jobless claims looks hopeful. New claims dipped to 466,000 on Nov. 21, the fewest in more than a year and a level, if sustained, that is consistent with stronger payrolls.
The rapid shrinkage in claims is also consistent with the pattern seen in strong economic recoveries, according to economists at JPMorgan Chase (JPM). They note that the fall in claims is tracking the pace of decline seen in the strong rebounds following the 1973-74 and 1981-82 recessions, compared with the much more gradual decreases after the 1990-91 and 2001 recessions.
One ingredient still missing from a better consumer outlook is stronger faith in the future. That will depend on more jobs. With October unemployment at 10.2%, consumer confidence in November, while off its record low, remains close to its nadir in the 1990-91 recession. For now, though, the data show that working families are already feeling better about lifting their spending, and that could be welcome news for retailers this holiday season.