U.S.: Consumers Can't Shoulder the Load by Themselves
If this is a recession, someone forgot to tell consumers. Coming off of a record 7.1% surge in retail sales in October, they remained in a shopping mood in November, according to early reports on store sales and car buying. Consumer resilience is providing an unexpected boost to the economy this quarter.
At first, the October retail jump might seem like a flash in the pan caused by extremely generous, but temporary, car incentives. And indeed, sales will give back some of those gains in coming months. However, consumers have the means to keep spending into the new year. Lower mortgage rates, falling energy prices, and the tax rebate program have combined to pump billions into household buying power and put household balance sheets in better shape (charts). Plus, rapid progress in the war against terrorism in Afghanistan should help to bolster consumer confidence.
The surprising fortitude of consumers points up a curious conundrum, though: If U.S. shoppers are soldiering on, then why are manufacturers still mired in a recession? Two reasons: First, sources other than current U.S. output, such as existing inventories and imports, are satisfying consumer demand. Second, and more important, manufacturing's top problem stems from the collapse of the tech sector.
The tech outlook depends more on a recovery in capital spending than on activity at shopping malls. Holiday sales may beat projections this year, but that won't help the industrial sector whittle away its overhang of computers, communications equipment, and other high-tech gear. Despite consumers' grit, the economy cannot mount a true recovery until the industrial sector returns to health, and that will take some time.
CONSUMER RESILIENCE in the face of massive layoffs might seem irrational. Certainly job jitters have dimmed confidence, and pay raises are shrinking. Moreover, the jobless rate will continue to rise until the economy can grow at a pace above its long-term trend of about 3%. Job worries and smaller income gains will temper consumer moods well into 2002.
At the same time, however, households are getting a financial lift from sources besides wages and salaries. Outlays won't come roaring back to the 5% pace of 1999 and early 2000. But real consumer spending is on track to grow at an annual rate of 2% or so in the fourth quarter. That pace may well be healthy enough to offset the contractionary forces of the tech downturn, falling exports, and rising layoffs.
Households are benefiting greatly from this year's interest-rate cuts by the Federal Reserve and from the drop in long-term interest rates. Mortgage rates have dropped from 7.3% at the start of 2001 to about 6.5% now. The volume of mortgage refinancings hit a record in mid-November, says the Mortgage Bankers Assn., and the savings will be significant. Economists at Goldman, Sachs & Co. estimate that refi activity over the next year could free up about $100 billion in cash.
Household budgets are also getting help from the steep decline in energy prices. Crude oil fell below $18 per barrel after oil producers were unable to agree on output quotas. If prices stabilize at current levels, BusinessWeek estimates that consumers will save nearly $50 billion between the second quarter of 2001 and the second quarter of 2002 from lower gas prices, with additional savings from cheaper heating oil this winter.
The tax rebate program also improved the consumer outlook, although not because people spent the money, as had been expected. Instead, the bulk of the $38 billion went into savings and to pay off old debts, two moves that improve balance sheets. Since July, when the rebate program began, installment credit has grown by $2.6 billion per month, compared with an average of $9.6 billion in the first half of 2001.
Lastly, low nonenergy inflation and the 20% rally in the stock market since late September will also bolster spending in coming months, even in the face of rising unemployment and continued uncertainty.
UNFORTUNATELY, U.S. MANUFACTURERS haven't been able to take advantage of most of these spending gains. Industrial production fell 1.1% in October; manufacturing output alone was off 1.2%. Production has fallen for 13 months in a row, the longest stretch of declines since the Great Depression. In October, the average operating rate for all industry hit 74.8%, the lowest rate in more than 18 years.
One reason why current production has not matched the uptrend in consumer demand is that much of the spending is being satisfied by goods already in inventory. For instance, unit sales of cars and light trucks surged 34% in October, thanks to interest-free financing, but vehicle production fell 4.2%. Almost all of the sales likely came from dealers' stocks. Ward's Automotive Reports says that vehicle inventories typically rise 6% or 7% between September and October. This year, stock levels fell 9.4%.
For economic growth, demand satisfied out of inventories is a wash. Inventories shrank in the first three quarters of this year, subtracting just over one percentage point from real gross domestic product growth, and Detroit's experience suggests overall stockpiles are declining again in this quarter. Inventory drawdowns could offset some of the contribution to this quarter's growth coming from the consumer sector.
RISING IMPORTS are another source of consumer goods. September 11-related insurance claims on overseas insurers narrowed the trade deficit to $18.7 billion in September from August's $27.1 billion. Both exports and imports fell in part because of tighter security measures. Even before September, though, imports were falling, as overall U.S. demand slowed, but the dropoff was less evident in consumer products. Over the past year, total goods imports have fallen 14.1%. Consumer imports were off only 3.7%.
The biggest decline has come in the import of capital machinery, which goes back to manufacturing's No. 1 problem: the tech wreck. Past overinvestment in computer gear, the collapse of the dot-com sector, and falling demand overseas triggered the decline of tech output starting late last year. As recently as a year ago, the production of high-tech gear--including computers, communications equipment, peripherals, and semiconductors--was growing at nearly 60% a year. Since October, 2001, output has shrunk 12.5% (chart). Tech equipment makes up only 9% of manufacturing shipments, but it has accounted for a quarter of the drop in factory sales.
Changes in household spending will do little to correct that huge problem. The best the economy can hope for is that solid gains in consumer spending will offset some of the drag from the tech collapse. So far this year, and even after the shock of September 11, consumers have proved willing to carry the burden.
By James C. Cooper & Kathleen Madigan