A Vicious Cycle Sets In

As Consumers Pull Back, A Vicious Cycle Sets In

By Moneynews.com | 15 January 2008

Consumers are in trouble, and many experts believe weakness in personal spending will send the economy into recession. Indeed some believe it already has. From low- and middle-end retailers to hoity-toity luxury stores, sales are slumping. Target reported that same-store sales dropped 5 percent in December from a year earlier, while Nordstrom sales fell 4 percent. And that was nothing compared to the carnage at Kohl’s— an 11 percent plunge— and at Macy’s, where sales fell 7.9 percent. "This is the real deal: consumers are slowing down across the spectrum,” David Schick, a retail analyst at Stifel Nicolaus, a St. Louis securities firm, told The New York Times.

Consumer spending accounts for 70 percent of economic output (GDP). So any weakness in that sector represents very bad news for the economy. The nation hasn’t seen a quarterly decline in personal consumption since 1991, when the economy was in recession. The shallow economic downturn of 2001 took place without such a drop. If December’s trend continues, spending could decrease into the first quarter of 2008.

The vicious cycle started with the 7 percent drop in home prices since 2006. That made it tougher for consumers to borrow against their homes— borrowing that had buttressed spending since 2001. Housing gurus are now calling for a housing decline of 20 percent, even 30 percent more. Soaring food and energy prices also put a dent in the consumer. Full year inflation for 2007 at the wholesale level came in at 6.3%, several times over the official government consumer index. The only question is, how much did companies pass on?

Now, fear among businesses over the consumer spending slowdown has made them more reluctant to hire and give raises, further crimping consumer spending. The housing meltdown has pushed consumers to take on auto loans and credit-card debt, putting further pressure on the credit markets which have suffered already from the subprime mortgage crisis. Debt is now 18.7 percent of assets for households and non-profit organizations, the Federal Reserve reports.

Plenty of analysts think much of the auto loans and credit card debt will turn sour, just as so many subprime mortgages did. That in turn would mean another crisis for the credit markets and a second, equally severe blow for the economy. "Households are in terrible shape right now," Paul Kasriel, chief economist at Northern Trust bank, told The Wall Street Journal. "They don’t have any reserves to really fall back on.” Kasriel sees a 65 percent chance of recession this year.

That makes him an optimist compared to David Rosenberg, chief North American economist Merrill Lynch. "The question is not whether we will have a recession, but how deep and prolonged it will be," he told The New York Times. Rosenberg and others think the Federal Reserve won’t be able to cut interest rates fast enough, and the White House and Congress won’t be able to implement tax cuts and spending hikes fast enough to prevent recession. It takes at least six months for rate cuts to take effect. The small cuts taken to date, for instance, are not even in play— yet.

Over the last year, as poor and middle-class consumers began to slash their spending, the wealthy, buoyed by stock market gains, took up the slack. Now, however, even the rich are reining in their shopping sprees. The fancy jewelry chain Tiffany reported that sales at its U.S. stores dipped 2 percent in December from a year ago. "It’s a reaction to the general economic uncertainty everyone is feeling," Tiffany chief executive Michael Kowalski told The New York Times. "There are housing price declines and financial market instability. There is a lot of caution out there, and it’s reflected in jewelry sales."

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Normxxx    
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