U.S.: Consumers Will Keep Carrying the Ball

True, jobs aren't back. But tax cuts and refinancings are doing the trick

The surprising deterioration of the labor markets in August would seem to throw a wrench into increasing expectations of strong economic growth in the second half. After all, consumers can't possibly keep leading this recovery without a pickup in job growth, can they?

Yes, they can in the short run. Despite last month's job losses, back-to-school sales and vehicle buying were strong, and September is looking busy for retailers, too. Consumers are reaping the benefits of tax cuts and low interest rates, policy moves that give households extra income. Plus, rising stock prices are adding to wealth. These positive trends provide a bridge for consumers to cross until demand gets another boost when businesses start hiring once more.

Where Layoffs Are Greatest
The spurt comes at an opportune time. Businesses are buying new equipment again, inventories need rebuilding, and the economy in general shows signs of renewed vigor. The Institute for Supply Management's business activity index for the nonmanufacturing sector has risen for five months in a row, with the August index at a high of 65.1%.

Also, factory orders rose 1.6% in July, while inventories fell 0.5%. The mix suggests factories will have to increase production to meet new demand. And the National Federation of Independent Business said its small-business optimism index jumped a record 4.1 points in August, to 104.7.

These upbeat reports suggest the economy in the second half could post the best back-to-back quarterly growth rates since early 2000. The strong performance underscores the notion that, with the right policy and accommodative financial conditions in place, consumers will keep shopping despite concerns over jobs.

OF COURSE, LABOR MARKETS MATTER. That's why the news of 93,000 more jobs lost in August was a head-turner. Economists had expected a small gain in jobs. Instead, the August decline brought the number of layoffs this year to 437,000.

All of the recent job losses have been in manufacturing. Since the recovery began in November, 2001, factory payrolls have shrunk by 1.2 million, while employment elsewhere has grown by 97,000.

Also, the dip in the unemployment rate, to 6.1% from July's 6.2%, was not a signal of labor-market improvement. The drop was caused by more people leaving the labor force. The percentage of the U.S. adult population working or looking for work stayed at 66.2%, the lowest participation rate in a decade.

Tax Cuts Pump Up Take-Home Payl
One bit of good news came from the continued advance in temporary-help positions. Businesses usually take on contingent workers until they feel confident enough to add permanent positions. And temp help has grown strongly for four months in a row.

Moreover, although the Labor Dept.'s survey of businesses shows continued layoffs, its survey of 60,000 households shows an increase of 868,000 jobs over the past year. About 140,000 of those jobs were in nonfarm industries, while 558,000 jobs reflected people listing themselves as self-employed.

It might be easy to dismiss the rise in self-employment as merely a way for some to deny their unemployed status. But the trend in proprietors' income -- earnings derived mostly from privately owned businesses -- supports the idea that this jobless recovery is pushing more people to become successful entrepreneurs. Nonfarm proprietors' income was up 9.1% in the year ended in July, a pace equal to the gains posted in the 1990s boom. These earnings, while 10% of all personal income, have accounted for nearly a quarter of the increase in overall income over the past year. Those gains partly explain why consumer demand is strong even while businesses are reluctant to hire.

THE TWO BIGGEST REASONS, though, are the July tax cuts and mortgage refinancings. The tax cuts, along with the child-credit rebate checks, should provide $35 billion in extra cash in the second half. The boost can already be seen in the July data on personal income. Real income was flat, but aftertax pay jumped 1.3%. That was the largest gain since the earlier Bush tax cuts were implemented in January, 2002.

Meanwhile, homeowners are improving their finances by refinancing their mortgages. When long-term interest rates fell to 45-year lows in late spring, refi applications hit a record. As these loans close, millions of homeowners will lower their house payments or liquefy thousands of dollars of their homes' net equity.

Federal Reserve Chairman Alan Greenspan has focused on the boost that refinancings give to current spending. But the refi madness of the past year has come at a cost. For the first time in a decade, housing wealth fell in the second quarter. According to the latest Fed data, owners' net equity in real estate fell by $45 billion, the biggest drop since the first quarter of 1993.

Back in the early 1990s, the drop was caused by a flattening-out in home values. This time, the decline can be traced to the growth in mortgages overwhelming the increase in home values. With refi activity slowing, housing equity should turn up in coming quarters. That suggests wealth should remain on the rise for the rest of the year, especially since balance sheets will also get a boost from the ongoing gains in the stock market.

INDEED, THE STOCK MARKET RALLY was mainly responsible for last quarter's advance in household wealth. According to the Fed, net worth -- personal assets minus liabilities -- edged up by $1.7 trillion in the second quarter from the first. Personal holdings of stocks and mutual funds increased by $944 billion. Consumers also boosted the amount of money in their savings accounts.

After the bear stock market caused wealth to shrink from 2000 to mid-2002, consumer balance sheets are on the mend. At $41.2 trillion in the second quarter, total household wealth is just 5% shy of equalling its record of 2000. If the equity gains continue and refis slow, net worth should overtake the old peak within the next year. That's another plus for future spending, since households tend to use a small percentage of their long-held wealth to finance current outlays.

Household Wealth Stages a Comeback
Taken together, the latest data on wealth, refinancings, and tax cuts mean consumers will increase their purchases throughout the second half. But those supports can last only so long. By early 2004, the lift from tax cuts will peter out, and cashouts from refinancings will be much lower.

As any economist can tell you, job and wage growth are the prime movers of consumer spending in the long run. Businesses must start hiring if the economy is to maintain its new momentum. Nascent signs, from the rise in temp jobs to the surprise strength in demand, suggest that help-wanted signs will soon be appearing in greater numbers. That's good news for the 2004 outlook -- and for the millions of job-seekers around the country.

By James C. Cooper & Kathleen Madigan

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