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Drop in Consumer Spending Could Spell Trouble for Economic Recovery

By Don Miller
Associate Editor
Money Morning

U.S. consumers curtailed spending in September for the first time in five months the government reported on Friday.  Combined with a weak report on consumer sentiment, it increased fears the economic recovery could falter as government stimulus spending winds down, sending the stock market into a downward spiral.

The news sent the Dow Jones Industrial Average plummeting by 294.85 points, or 2.51%, on Friday to close at 9,712.73.  Meanwhile, the Standard & Poor’s 500 Index fell by 29.93 points, or 2.81%, to close at 1,036.18 and the Nasdaq Composite Index plunged 52.44 points, or 2.5% to close at 2,045.11.

The Commerce Department said purchases fell by 0.5%, after gaining 1.4% in August, matching the median estimate of economists surveyed by Bloomberg News. But consumers continued to increase their savings even as their incomes dropped.

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The Reuters/University of Michigan’s consumer sentiment index rose to 70.6 in late October, up from 69.4 earlier in the month. However, that’s still down from September’s reading of 73.5.

“Consumers were more optimistic about prospects for the national economy, inflation, and the unemployment rate, although most consumers thought their own finances would remain problematic for some time,” said Richard Curtin, the director of the survey.

Stagnant wages and mounting concern over surging unemployment are increasing fears that consumers will pull back this winter as the government’s spending programs run out of funding.

“The consumer went out spending in August, but once that incentive was taken away they didn’t have the same reason to spend as much,” Jonathan Basile, an economist at Credit Suisse Group AG (NYSE ADR: CS) in New York told Bloomberg. “Consumers are going to be selective and not necessarily aggressive going into the holiday season.”

Consumer spending, which accounts for almost 70% of all U.S. economic activity, got a shot in the arm in the third quarter from the popular Car Allowance Rebate System (CARS), better known as the “cash for clunkers” program, which offered discounts on some new automobile purchases.

Government data on Thursday showed the economy grew at a 3.5% annual rate in the third quarter, probably ending the recession that began in December 2007. Consumer spending for the July-Sept. quarter actually gained 3.4%, thanks in large part to cash for clunkers, which ended in August.

But with a “jobless recovery” on the horizon, the labor market could be too weak to support domestic demand, leading to concerns the economy’s nascent recovery could stumble once the government support wanes.

Wages and salaries fell 0.2% after a 0.2% gain the prior month and employment costs in the United States rose 0.4% in the third quarter.  While wages and salaries from year-ago levels increased by 1.5%, it was the smallest increase since 1982, when record keeping began.

“The issue of poor labor income remains quite front and center,” Pierre Ellis, senior economist at Decision Economics in New York told Reuters. “The ability to finance consumer spending growth will come down to improvement in the labor market.”

And even though incomes dropped, Americans increased savings, further raising concerns about consumer confidence. Savings increased to an annual rate of $355.6 billion, pushing the savings rate up to 3.3% last month from 2.8% in August.

“It sets up a very weak fourth quarter for consumption. It might be around flat to up 1% annualized in the fourth quarter,” Ian Morris, chief economist at HSBC Securities in New York told Reuters. “But if inventories add and you get some rise in business investment, you could get a much more decent fourth-quarter (GDP gain) of around 3%.”

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  1. Pingback by What Investors Should Look for in Today's Fed Statement on 4 November 2009:

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