Will Consumers (Ever) Spend Again?

Consumers account for about 70 percent of economic activity in this country, but have become extremely fickle in this downturn. They have begun to save more and spend less. But that doesn’t mean consumer spending won’t give a boost to economic growth. But banking must recover first, in order to cure the credit crisis.

Business Week’s chief economist Mike Mandel says that one portion of consumer spending has held up—spending on services has grown 3.3 percent since February 2008. Why? Because much of it is in healthcare outlays, which is up $112 billion, according to Mandel. And 85 percent of health-care spending is by government and employers and so not directly out of consumers’ pockets.

Another part of this spending is by non-profits, both religious and foundations. For example, the Gates Foundation plans to boost its spending by 15 percent this year to $3.8 billion. All this means it is mainly durable goods spending—for goods that last more than 3 years—that is the real drag on economic growth. And orders for durable goods just shot up 6 percent in February, the first increase in 6 months.

So the outline of an economic recovery is beginning to take shape. Banks are beginning to recover. Wells Fargo has just reported record profits for the first quarter due to huge mortgage volume, and Bank of America recently said it might be able pay back all of its $40 billion in government TARP funds by next year.

And one sign of a credit recovery is that mortgage rates are at record lows, with even the jumbo mortgage market showing signs of life. Jumbo, non-negatively amortized ARMs with 3 to 10 year fixed rates for multi-million dollar loans have recent quotes of 4.75 to 5.50 percent with a 1 point origination fee.

Personal savings are also soaring, as pictured in the graph, up more than 4 percent in January and February, after being close to zero since 2005. This is making consumers feel wealthier. The shaded areas in the graph are periods of recessions.

Retail sales are the best indicator of improved consumer spending, with sales up in January and February after declining for much of last year. The Commerce Dept. graph shows that auto sales are still in decline, but General Merchandise sales have risen 1 percent.

Housing will probably be the final sector to recover, once banking and the credit markets are sound again. Certain areas in California and Florida are showing signs of life, with the California Association of Realtors reporting that home sales surged 80 percent in February. This is while February’s national existing-home sales rose 5 percent, with the all-important existing-home inventory declining from 11 months to a 9.8-month supply at the current sales rate. It was in 2005 that inventories began to rise to unsustainable levels, as the last graph portrays.

What we see is the beginning of an economic recovery with consumer spending giving it a necessary boost, but it is the banks and credit markets that must recover before it becomes meaningful on Main Street.

Harlan Green © 2009