Originally created 08/07/02

Economy's direction may sit in the hands of consumers



NEW YORK -- Will they shop or will they stop?

Whether consumers keep spending or tighten their pursestrings could ultimately determine where the economy goes next.

New dismal economic news regarding job growth and business activity has raised concerns that the economy, which appeared to be strengthening, is now sputtering and could be heading back into a recession.

And this is sure to happen if consumers, who have been mostly resilient over the last two years despite all the economic woes and a tumbling stock market, put a freeze on buying.

"In the end, it boils down to the American consumer. It always does," Morgan Stanley chief economist Stephen Roach wrote in a recent report.

Consumer spending accounts for two-thirds of economic activity, and therefore it is a crucial gauge in monitoring how the economy behaves.

Through much of the recent recession and the bumpy slide on Wall Street, consumers were cautious, yet didn't curb their spending much. Thanks to low mortgage rates, they've been eager to buy new homes, and interest-free financing has prompted many to buy new cars.

Their spending has also been buoyed by consistent income growth, which means many Americans get a regular jolt to their paychecks.

"Consumers have been confident about spending because their incomes have been getting bigger and income today is more important to most people than future wealth," said Gary Thayer, chief economist at A.G. Edwards & Sons Inc. in St. Louis.

Their willingness to spend helped lift the economy from its recession earlier this year. But now the big question is whether they'll keep buying in the crucial months ahead.

Americans' confidence has been shaken by this summer's stock-market bloodbath and a wave of corporate scandals, leaving many nervous about what troubles are ahead - especially over possible layoffs.

It's now time watch to see if the steep slide in consumer sentiment, which hit a five-month low in July, translates into reduced spending. If consumers scale back now, it could almost guarantee that the economy falls back into a recession, which economists call a double dip.

Already, other economic fundamentals are pointing that way. The economy is now growing at an annual rate of 1.1 percent, far below the 5 percent rate seen in the first quarter of this year.

Business purchases are down significantly, as is construction spending. Companies, worried about what's to come, aren't creating many jobs, and there are new fears that the unemployment rate could rise by the fall.

"There is no question that there is a risk of consumers pulling back and taking the economy with them," said Scott Hoyt, director of consumer economics at Economy.com in West Chester, Pa.

Just consider the consumers' role in the economy.

If consumers stop shopping for clothes, that pushes down retailers' sales. Over the long term, merchants start laying off employees and closing down unprofitable stores. At the same time, manufacturers lose money and are forced to do their own cost-cutting.

As a result, jobs are lost and few are created. Unemployed workers, in turn, curb their buying, and the trickle-down effect rumbles through much of the economy.

So far, consumers are giving mixed signals of what they'll do next.

Auto sales continue to rise, thanks to extended no-financing programs. There were 18.1 million vehicles sold in July vs. an average of 16.1 million the previous two months.

New-home sales are up, and while there was an 11.7 percent dive in existing-home sales in June, they've been running at brisk levels all year and 2002 is still expected to set records.

But there's been some sluggish buying at the mall.

A number of teen retailers, including Gadzooks and Hot Topic, announced they would miss earnings expectations for the quarter, caused in part by a slump in sales during the last few weeks of July. That's raised fears that parents might be reining in their free-spending teens as they head out for back-to-school shopping.

Target's July sales were also disappointing, mostly due to weakness in its department stores division. Even retailing giant Wal-Mart has seen some pullback, with July sales likely to be at the low end of expectations.

"There has been a psychological downshift on the part of the consumer, and it is unclear how that will play out going forward," said John Morris, a managing director at the investment bank Gerard Klauer Mattison. "

There's no doubt that all eyes are watching what happens next. Consumers are at a crossroads right now, and what they decide will have broad implications.

"In my view, the excesses of the American consumer will go down in history as the hallmark of the roaring 1990s. Those excesses have yet to be purged," said Morgan Stanley's Roach. "There may be good reason to suspect that such a moment of truth may be at hand."