United States: April May Be the Cruelest Month for the American Consumer Richard Berner (New York)

Resilient consumer demand has been the brightest light in an otherwise dreary winter economic landscape, keeping the economy out of recession. Real consumer outlays in the first quarter grew at a 3–3 1/2% pace as sales of discretionary big-ticket durables such as cars and trucks and electronic gear, and of nonessential nondurables such as dining out and clothing, more than held their own. But in my view, time is running out on the seemingly unflappable American consumer. Among the reasons: Job and income growth is slowing dramatically, Uncle Sam's tax bite is getting bigger, energy prices are poised to rebound, and balance sheets are eroding.

In a nutshell, I believe retrenchment lies ahead. Here's why.

Most important, the foundations of income and job growth are becoming increasingly shaky. "Core" real wage and salary income growth has slowed to just 2% at an annual rate, and further deceleration is likely. Job gains turned into losses in March, and the rising level of jobless claims hints that further slippage lies ahead. In addition, real wage growth slid below 1% annualized in the first quarter from 2.8% in the fall, as earnings growth faded and headline inflation (measured by the personal consumption price index) jumped. The prognosis is no brighter here. A sinking stock market isn't just trimming perceptions of wealth. It has left many stock options worthless, depriving some consumers of cash from their exercise. We won't know for a couple of years just how large that source of discretionary income recently has become, but it's hard to imagine that the mother of all bull markets did not spawn a huge surge in spendable cash for more than just top management.

Moreover, April may be especially cruel for taxpayers, as surging tax payments sap spendable income. Dave Greenlaw estimates that April 2001 tax payments may rise by 15% from a year ago as final settlements on last year's capital gains, options income, and mutual fund distributions come due. In addition, Ted Wieseman notes that as of March 23, tax refunds this year are running 1.7% behind 2000's tally (see "Tax Time," and "More Tax Time," both in Inside the US Economy, April 10, 2001). In all, final payments could be some $20 billion higher this year than in 2000, trimming about 0.3% from disposable income.

Rebounding energy quotes will also probably drain discretionary spending power. California's energy woes are the most visible sign that further trouble lies ahead (see "California: No Longer Dreaming," Global Economic Forum, April 12, 2001), but energy prices seem likely to rise again on a nationwide basis. Last year's surging natural gas prices failed to call forth significant supply increases, as it takes more than a year for new exploration to bear fruit. A hot summer would likely strain electricity generation and thus natural gas supplies, pushing prices back up. Gasoline inventories are below last year's levels, and the second summer of Phase II regulations for reformulated gasoline is likely to hike prices up at least to last year's levels, or 17% over April's trough. Wholesale gasoline quotes are already up 7% in the past two weeks.

Adding to the pain, the wealth effect likely will finally work in reverse. While stock prices (measured by the Wilshire 5000) have rebounded some 8% from their early-April lows, broad price gauges are still below levels of two years ago, 20% off their peaks in early 2000, and 10% below their levels at the beginning of the year. Prices would have to rally significantly and for a while to undo this damage. So why hasn't this damage to balance sheets yet created more consumer caution? First, the duration as well as the magnitude of a slide in equity values is important in gauging the impact. Fed research hints that the bull market's persistence and record-setting gains may have stretched out the traditional lags between changes in wealth and changes in spending, but that the connection is robust (see "A Primer on the Economics and Time Series Econometrics of Wealth Effects," Morris A. Davis and Michael G. Palumbo, Finance and Economics Discussion Series Paper 2001-09, Federal Reserve Board, Washington, DC). Second, the 8.1% rise in home prices has cushioned the blow to household balance sheets from the loss in equity values. For the average consumer, the equity in his or her home is a more important asset than equity portfolios, and is potent collateral (see "On Borrowed Time," Inside the U.S. Economy, April 10, 2001). Yet home prices are unlikely to rise as they did in 2000; indeed, there are anecdotal reports that the housing boom is turning to bust in some metropolitan areas.

Until now, ample credit availability has enabled consumers to escape these harsh fundamentals. Indeed, the recent spending spree has all the classic earmarks of "lifestyle defense." That is, fundamentals are eroding, but consumers borrow or slow repayment of debt to avoid cutting back from past spending norms. Soaring consumer credit and home equity loans testify to consumers' willingness to finance spending with debt; the former jumping at an 11.5% rate in January and February, and the latter at a 15.5% clip at commercial banks in the period between December 31 and April 4. However, lenders may now balk at supporting these habits, as consumer credit quality is beginning to erode. Charge-offs on consumer loans at commercial banks jumped by 40 basis points in the second half of 2000, and Morgan Stanley specialty finance analyst Ken Posner notes that consumer bankruptcies recently soared by 37% over the past year. A jump was expected following the mooting of more stringent bankruptcy laws, but this level is double the expected surge in filings.

Small wonder that consumer anxiety about the economy and personal finances edged higher in early April. Confidence measured by the University of Michigan index fell by nearly four points, and consumers' appraisal of current conditions fell to levels last seen in November 1993. Favorable attitudes toward buying the big-ticket durables on which consumers binged in the first quarter fell to their lowest level in eight years. There's little doubt in our mind that a pullback in such durable outlays will quickly contribute to weaker spending. But big-ticket durables aren't the only spending category at risk. Retrenchment in some major discretionary services outlays also seems likely. Recreation outlays, including amusements, cable TV, and Internet access, which accounted for 11% of the nominal growth in services spending last year, may well see a pullback. And purchases of brokerage and other financial services are already showing vulnerability. Both are much more cyclical than commonly assumed.

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-- Carl Jenkins (somewherepress@aol.com), April 16, 2001