Commentary: The Firepower In Consumers' Pockets

Why they'll keep spending despite the job market

As the U.S. has struggled to right itself from the recession of '01, consumer spending has stood out as the one bright spot for the economy. While America's dogged shoppers pulled back in the wake of September 11 and in the runup to last year's Iraq war, overall spending never actually fell. That gave much-needed support to the rest of the economy. Now, consumers once again face obstacles to their free-spending ways -- specifically the painfully slow improvement in the job market, high levels of personal debt, and the pinch consumers would feel if inflation and interest rates were to shoot up. "Households are pretty stretched," says Paul Kasriel, chief economist at Northern Trust Co. in Chicago. "That's a risk to consumer spending." Fueling such concerns: a Mar. 26 Commerce Dept. report that consumer outlays from January to February were essentially flat after stripping out the effects of inflation.

But it is premature to count the consumer out just yet. In the short run, spending will be shored up by new tax refunds and yet another round of mortgage refinancings. More significantly, the longer-term outlook is improving. Thanks to rising stock and housing prices, household net worth climbed $4.6 trillion last year, to $44.4 trillion, more than recouping the losses from the bursting of the Wall Street bubble.

What's more, Mar. 26 Commerce Dept. figures also showed that wages and salaries are stronger than first thought. The combined financial firepower should give consumers the wherewithal to keep spending even in the face of a lackluster job market and the threat of higher inflation.

There's no doubt that the weak jobs picture of recent months has taken a toll on consumers' spirits. The Conference Board reported on Mar. 30 that consumer confidence fell to its lowest level in five months, in part because of the employment picture.

The flip side of the faltering jobs market, however, is superstrong productivity growth, which has averaged more than 4 1/2% annually over the past two years. That's yielding benefits for consumers in the form of increased wealth. And economists reckon that 3 cents to 5 cents of every dollar increase in wealth gets spent. Despite the recent hiccup, stock prices are up more than 35% from their lows of March, 2003, thanks in no small part to a productivity-powered surge in corporate profit. Earnings rose nearly 30% in the fourth quarter, according to Commerce Dept. figures. Once again, America's more than 90 million investors are opening their brokerage statements and smiling.

Productivity isn't just padding consumers' stock portfolios. It's also helping to boost housing wealth. The productivity bonanza holds down corporate costs, and therefore inflation. That, in turn, lets the Federal Reserve keep interest rates at rock-bottom levels. The lower rates have made housing more affordable, hiking demand. And prices are responding. The Office of Federal Housing Enterprise Oversight reports that home prices spurted 8% in the fourth quarter. As homeowners refinance their mortgages, they're taking some of that money out and spending it.

HIGHER DIVIDENDS. More important, there are signs that stronger productivity is starting to bring some payoff to workers' pocketbooks. Using recently available company data collected by the states, the Commerce Dept.'s Bureau of Economic Analysis on Mar. 26 sharply revised upward its estimates of wages, salaries, and personal income dating back to July of last year. The revised figures show that personal income in January alone was $50 billion higher on an annual basis than first reported. The story behind the numbers: With productivity soaring, companies are finding they can pay their workers more without materially eating into their profits.

With household wealth rising and wages starting to pick up, the outlook for consumer spending is brightening. While the February data were undoubtedly disappointing, they followed robust consumer spending over the previous three months. What's more, compared with last year, spending in February rose a respectable 5.8% -- and strong growth is expected to continue. Wal-Mart Stores Inc. (WMT ), the nation's largest retailer, said on Mar. 29 that sales for the month should hit the high end of the 4% to 6% growth it expects. And Best Buy Co., the nation's largest consumer electronics chain, forecast on Mar. 31 rosy earnings ahead after reporting a 50% increase in profits in its fiscal fourth quarter. In fact, consultant Macroeconomic Advisers LLC believe that consumer spending will grow at about a 4% annual clip in the first half of 2004.

Of course, consumers could take a knock if inflation suddenly spiked. Already, they're feeling the pinch from rising gasoline prices, which are up more than 15% since the end of last year. Fortunately, though, tax refunds are up as well, courtesy of last year's tax-cut legislation, and that's offsetting the impact of higher energy costs on consumers.

If inflation became more widespread and the Fed felt compelled to jack up interest rates in response, that would be more worrisome. Indeed, even at today's low rates, some borrowers are having trouble keeping up. A March survey by research firm Cambridge Consumer Credit Index found that 13% of Americans are making minimum or no payments on their credit-card balances.

The explosion of consumer debt in recent years means that Americans are having to devote more and more of their income to servicing it. As interest rates rise, that problem could get worse. According to the latest figures from the Fed, household debt payments totaled 13.14% of disposable income in the third quarter of 2003, down only slightly from the record 13.32% hit at the end of 2002.

Still, many consumers have taken advantage of the low interest rates of recent years to lock in their borrowing costs, insulating themselves against the time when interest rates start to rise. "People have strengthened their balance sheets," says Anthony Chan, chief economist at Banc One Investment Advisers. Household liabilities rose 10% last year, but the bulk of that was in fixed-rate home mortgages. While there has recently been a spate of new, riskier mortgage products for homeowners, fixed rates are still by far the borrowing instrument of choice. Economist Richard Berner of Morgan Stanley says more than 90% of mortgages in the past six years have been either fixed-rate loans or hybrid adjustable-rate mortgages that carry three to seven years of interest protection.

Taking it all together, the outlook for consumers is brightening. With wealth and wages rising, shoppers once again look set to confound the critics who fear the Great American Spending Marathon is over.

By Rich Miller

    Before it's here, it's on the Bloomberg Terminal.