Commentary: Consumers Shopped. Will They Drop?

By Rich Miller

As the U.S. economy slid into recession last year, there was one shaft of light penetrating the econo-funk. Consumers had an uncanny ability to keep on spending right through the tech bust, a market dip, September 11, and the collapse of corporate profits. Americans' purchases of everything from cars to homes to electronics gear helped the economy weather the downturn. "The consumer was the hero in 2001," says economist James Glassman of J.P. Morgan Securities.

Now the hero's halo is looking tarnished, with sobering implications for the still-struggling recovery. On June 13, the Commerce Dept. reported that retail sales slumped 0.9% in May, their biggest decline in six months. The University of Michigan weighed in the next day with the news that consumer confidence for June dipped to its lowest level of the year. And as if that weren't enough, both Apple Computer Inc. (AAPL ) and Advanced Micro Devices Inc. (AMD ) singled out weak consumer spending in issuing profit warnings on June 18.

Of course, the doom-and-gloomers have been counting consumers out ever since the economy started faltering a year-and-a-half ago--and they have been wrong every time. This time, though, they may be right. The reason: The strong wage gains that continued in the recession may be petering out.

Those gains--after adjusting for inflation, average hourly earnings rose 3% in 2001--were a key reason why consumers kept spending so freely during the downturn. Normally, wages take a hit when the economy heads south. But they didn't this time, in part because companies were still smarting from the supertight labor markets of the late 1990s and didn't want to risk losing valued workers. At the same time, inflation was falling, further boosting consumer purchasing power. The drop in energy prices alone is reckoned to have pumped up pocketbooks by $50 billion in 2001.

Now, however, rising unemployment and falling corporate profits appear to be taking their toll on wages at last. After climbing steadily last year, real average hourly earnings have turned down, dipping two cents to $8.12 in May, according to Labor Dept. data. Shell-shocked by last year's plunge in profits, companies are taking a harder line in salary negotiations with their workers. And with unemployment nearly two percentage points higher than its 3.9% pre-recession low, they can get away with it. Manpower Inc. CEO Jeffrey A. Joerres, whose temporary workers are on the front line of the labor market, says the average temp is making a nickel less an hour than last fall. He sees no change in that for the next six months.

An uptick in inflation is also eating into consumer purchasing power. Although consumer prices held steady in May, they've still risen at an annualized rate of nearly 3.4% over the past three months. Energy prices alone have skyrocketed 35% over the same period, despite a small dip in May.

To make matters worse, the slowdown in workers' real wages comes just as some other props to consumer spending are also giving way, notes Edward F. McKelvey, senior economist at Goldman, Sachs & Co. The $40 billion tax rebate last summer and big refunds early this year boosted buying power. But now those effects are waning. Consumers will have to wait until 2004 for the next big dollop of cash under President Bush's 10-year tax-cut plan.

The kick to consumption from mortgage refinancing by homeowners is also fading. Last year's refi boom pumped $80 billion into homeowners' pockets. But with mortgage rates above last year's lows, the refinancing frenzy has cooled off. The Mortgage Bankers' Assn. refinancing index stood at 1,764 in the week ended June 14, vs. a record high of 5,534 last November.

What's more, the sagging stock market is eating into the wealth of already stretched consumers. Economists reckon that consumers eventually reduce spending by three to five cents for every dollar decline in their wealth.

So does all that mean that consumer spending is about to collapse and the economy is headed for a dreaded double-dip recession? Not necessarily. The housing market is still superstrong. And early reports from retailers and auto dealers suggest that business bounced back in June after sliding in May.

Still, there's no doubt that consumers are tired after last year's heroics. Saving the economy from recession was one thing. But counting on consumers to propel the recovery at a time when wage gains are ebbing may be too much to ask, even for America's millions of avid mall rats.

Miller covers the economy from Washington.

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