Boom Rests on the Shoulders of Consumers
February 8, 1999
by Irwin Stelzer
Well, the forecasters have had their say, and agree that the performance of the American economy in 1999 will depend on just how consumers, who account for some 70 percent of the nation's GDP, behave in 1999. Most are not cheerful. Falling share prices will end consumers' binge, "bringing down the entire house of cards....We cannot time this pattern of events but we are convinced of its inevitability," says a new report by Cambridge professor Wynne Godley and Phillips & Drew analyst Bill Martin.
Americans saved almost nothing last year, according to officially reported savings figures. Indeed, in several months they spent more than they earned. As rising share prices ballooned their retirement accounts, Americans carpéd the diem, treating themselves to new cars, bigger houses, and swankier furniture. And to a host of services, including vacations on which to rest up from their shopping orgies, and personal trainers to keep them in shape for the next dash to the mall.
Surely, this can't continue. Share prices will fall, consumers will zip their wallets, and the economy will slow. Really?
So far, there is no sign of any of these gloomy developments. Share prices are bouyant, construction activity keeps rising, new home sales are running at a record annual rate, and new car sales in December astonished even the optimists in the auto industry, who are now expecting sales in 1999 to be almost as good.
Nor does the onset of a vicious downward spiral of share prices and consumer spending seem "inevitable". Start with the proposition that share prices must inevitably fall as profits are squeezed by cheap imports and rising labour costs. That ignores the fact that the failure of profits to grow in 1998 was due to the performance of the three sectors that dominate the share-price averages – finance, technology, and energy. Each had unique problems that are unlikely to be repeated in 1999, says Jeffrey Laderman, writing in Business Week. Financial houses took a beating on Russian debt, the technology companies suffered as heavy inventories were worked off, and the energy companies had not yet fully adjusted costs to the new era of low-priced oil.
This year should prove to be a different ball game. The financial institutions' write-offs should be moderate, firms such as Morgan Stanley are predicting a 25% increase in profits in the technology sector, and oil companies are cutting costs with a vengeance. Moreover, there should be no single event comparable to the General Motors strike, which cut the industry-wide earnings average by over one percentage point. This doesn't prove that share prices will indeed head towards the magical Dow 10,000 level, but it does suggest that it is by no means certain that profits will plunge by enough to scare consumers out of shares and out of the shops.
Remember: during the stock market plunge of last summer, only four percent of small investors sold shares, while 11 percent bought stock and 80 percent didn't change their holdings, according to a survey by Louis Harris & Associates.
Nor are consumers as stretched as the headline figures on savings would have you believe. Increases in the value of investors' portfolios and workers' retirement accounts are not counted as income by government statisticians. So if someone realizes a profit of, say, $10,000 on his shares, pays capital gains taxes of $3,000 and decides to spend $1,000 more than his actual wages, the official figures will say that he has negative savings of $4,000, even though he has added $6,000 to his bank balance.
A more meaningful indicator of the American's ability to continue the spending rate that has shored up the US and world economies, is the job market. Despite headlined lay-offs, the unemployment rate fell to a mere 4.3 percent last month, as new job creation soared.
This strong job market has produced some often overlooked results. Overall, personal incomes – after accounting for inflation and taxes – rose three percent last year. The 40 percent of earners who count on interest income or welfare checks didn't do that well, as interest rates dropped and state governments screwed down on welfare standards. But the 60 percent who count on paychecks saw their real wages shoot up by 6 percent. "Historically," says Business Week, "such rapid wage-and-salary growth has occurred only in the early stages of a recovery."
A final worry of those who think that American consumers can't continue to be the locomotive that pulls the economy at a good speed is Americans' mounting debt burden. But figures about what consumers owe must be treated with as much care as figures purporting to show that they aren't saving for a rainy day.
For one thing, a person whose portfolio and house have increased sharply in value, should not be considered poorer if he owes a bit more on his credit card. For another, falling interest rates mean that consumers can easily carry more debt without digging any deeper into his pocket.
Finally, figures on credit card debt are less and less a measure of consumers' inability to pay cash and more and more an indication of their desire to obtain the extras – most notably, free air miles – that come from using credit cards. Cash-rich Americans now use credit cards to pay for groceries, once a strictly for-cash purchase, and even for automobiles, to the extent that dealers will allow them to.
So don't write off American consumers just yet. Their persistent purchasing has not only kept the boom going, but has left retailers with a need to restock inventories in the next few months. It will take a bigger and more durable drop in share prices than any we saw in 1998, or those ever-possible "events, dear boy, events," that Harold Macmillan so feared, to turn 1999 into the year in which the cheering stopped.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.