U.S.: Is This One Burden Too Many for Consumers?
In two crucial respects, the consumer sector has reverted to where it was four years ago. Household net worth now equals the amount of wealth sloshing around the economy in 1999, and payrolls in February were where they were 31/2 years ago. The key difference between then and now, of course, is momentum. Back then, wealth and nonfarm payrolls were both surging, and real consumer spending was growing by a rapid 5% a year. Now, both are heading south, raising questions about whether consumers can keep the recovery going.
The stakes are high. Consumers have been the engine of this upturn, whether with purchases of goods and services or through demand for housing. But the heightened awareness of terrorism, the risks associated with a gulf war, rising energy prices, and the harsh winter have kept consumers from lifting their spending much this quarter. Now, fresh evidence of a weakening labor market adds another, more daunting, impediment (chart).
A consumer slowdown would clearly put this recovery at risk at the same time that executives, investors, and policymakers are realizing the war is not the only drag on the economy. Businesses still face drags that touched off the last recession, and executives show little inclination to boost production or hiring.
BUT A LASTING CONSUMER retrenchment is not a certainty. Shoppers have confounded expectations before. Remember, they were supposed to hunker down after September 11. Instead, they flocked to car dealers in record numbers to take advantage of 0% financing. Plus, a quick and successful completion of the war would most likely bolster consumer confidence and allow energy prices to recede some.
In a speech in late February, Federal Reserve Governor Ben S. Bernanke discussed the two key factors that affect consumers' ability and willingness to spend: real aftertax incomes and wealth. Here, the outlook is good. Despite weak job markets, lower taxes have allowed incomes to grow at a solid 3% pace, while households are still holding on to most of their wealth accumulated during the 1990s.
That speech was made two weeks before the Labor Dept.'s report on the February labor markets, which cast a decidedly dim light on job prospects. Payrolls plunged by 308,000, and the losses were widespread. Manufacturing cut another 53,000 jobs, bringing the sector's layoffs to 2.1 million since mid-2000. Retail jobs fell by 92,000, and construction slipped by 48,000.
Some of the job losses, especially in construction, could be attributed to the severe winter. Both the weather and the Code Orange terror alert also hurt retailing, transportation, and restaurants. Plus, some of 150,000 reservists called up in February were probably wrongly counted as unemployed. But even after accounting for those one-shot factors, the job picture still appears to have deteriorated, especially because the recent upward trend in new filings for jobless benefits suggests that the weakness continued into March.
Another disturbing trend is the growing length of unemployment. In February, the average duration of joblessness had stretched to a nine-year high of 18.6 weeks (chart), and 22.1% of the unemployed had been jobless for 27 weeks or longer, the biggest share since 1992. And despite February's relatively low 5.8% unemployment rate, many consumers are jittery about the job market. They're seeing relatives, friends, and former co-workers struggling to find new employment or are themselves in such a plight. The danger is that rising nervousness could impel consumers to pull back, save more, and spend less of their current income.
THE OTHER FACTOR influencing household spending is wealth, and the prognosis here is not as bad as the dreadful top-line number would suggest. Net worth has fallen for three years in a row, according to the latest Fed data. But the three-year cumulative loss of $4.2 trillion doesn't offset the $5 trillion gain in wealth for 1999 alone. From the end of the recession in 1991 to the stock market's peak in the first quarter of 2000, household net worth doubled, to $43.3 trillion. In other words, the current stock market falloff hasn't swept away all of the wealth built up during the last expansion.
Bernanke said the recent loss in wealth shaved about 11/2 percentage points from the growth in consumer spending in 2002. This year, he estimates that the drag should be only about one point, if the ratio of wealth to income stabilizes. Offsetting that will be a second-half boost to incomes, should the White House's tax plan be approved. Consequently, consumers with jobs will still have the wherewithal to keep spending at a modest pace.
Households have other assets besides stocks, and the values of those have been rising. In fact, excluding stock losses, net worth has risen in each of the past three years, and the biggest reason is housing. Home equity -- home values minus outstanding mortgages -- rose to $7.6 trillion at the end of 2002, up $419 billion from 2001. Home equity in 2002 retook the lead as householders' main asset (chart). From 1995 to 2001, stock holdings, either by direct investment or mutual funds, had been No.1. But last year, housing wealth outpaced households' $6.8 trillion in stock holdings.
THE HOME EQUITY GAIN came despite the rush of mortgage refinancings last year, including $550 billion in the fourth quarter alone. Much of the money cashed out during mortgage refis has gone to finance consumer spending. But the downside is that home equity as a percentage of total real estate assets had fallen to 55.6% at the end of 2002. That's a record low and far beneath the 66%-to-68% range of the 1970s and '80s.
Refi applications jumped to a record level in early March as mortgage rates continued to dip. Refinancing homeowners will get a boost to their finances once the new loans are approved, either from cashouts or from lower monthly payments. In addition, homeowners can tap into their home equity lines of credit, which have tax advantages over credit cards and auto loans.
While past refi activity has boosted household finances, another huge wave of refis later this year would not necessarily be a plus for consumers. That's because another rush to refinance would depend on interest rates falling substantially lower. And rates will probably fall only if the economy has indeed taken a turn for the worse.
That dismal outcome would stem from an outright retrenchment in the household sector, which has watched its wealth and the labor markets slip back to levels not seen in four years. But to keep the recovery afloat, consumers don't have to party like it's 1999. They just have to spend at a solid enough pace to keep the economy moving despite the drags of business paralysis and geopolitical risks. That's a task that consumers may yet prove they can handle.
By James C. Cooper & Kathleen Madigan