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Sept 3, 2010
by Don Azarias
The Commerce Department said the gross do mestic product (GDP), which serves as the barometer to measure economic growth, grew at an annual pace of 2.4 percent from April to June. That’s less than the 2.5 percent economists polled by Thomson Reuters had forecast. The report confirmed investors’ belief that the recovery is weakening as unemployment remains high and government stimulus programs end. Consumers cut back on their spending because of job worries while companies cut production and put a freeze on hiring because of slow sales. The figure was especially discouraging after the government revised firstquarter growth to a pace of 3.7 percent from 2.7 percent.
Surprisingly, the Dow Jones Industrial Average (DJIA), entering the first day of August was up 7.1 percent. The market’s big gains have come on strong corporate earnings and profit forecasts that conflict with economic reports that point to a slowdown. In the past few days, however, investors have been more focused on economic reports. Disappointing numbers on housing and unemployment and cautious words from the Federal Reserve have sent stocks lower.
Wealthy American consumers aren’t spending the way they used to. And the rest of us are feeling the unpleasant effect. The question is whether the rich will cut back so much as to tip the economy back into recession or if they will spend at least enough to sustain the recovery.
Their cutbacks help explain why the rebound could be stalling. The economy grew at just a 2.4 percent rate in the April-June quarter, the government said Friday, much slower than the 3.7 percent rate for the first quarter. Economists say overall consumer spending has slowed mainly because the richest 5 percent of Americans those earning at least $207,000 are buying less. They account for about 14 percent of total spending. These shoppers have retrenched as their investment values have sunk and home values have languished.
In addition, the most sweeping tax cuts in a generation are due to expire in January, and lawmakers are divided over whether the government can afford to make any of them permanent as the federal budget deficit continues to balloon. President Barack Obama wants to allow the top rates to increase next year for individuals making more than $200,000 and couples making more than $250,000. The wealthy may be keeping some money on the sidelines due to uncertainty over whether or not they will soon face higher taxes.
The Standard & Poor’s 500 stock index has tumbled 9.5 percent since its high-water mark in late April. Home values fell 3.2 percent in the first quarter, according to the Standard & Poor’s/Case-Shiller 20-city home price index. Think of the wealthy as the main engine of the economy: When they buy more, the economy hums. When they cut back, it sputters. The rest of us mainly go along for the ride. Earlier this year, gains in stock portfolios had boosted household wealth. And the rich responded by spending freely. That raised hopes the recovery would strengthen. But the dizzying plunge on Wall Street in May and June and lingering stock market turbulence have shrunk Americans’ wealth. The Dow fell 10 percent for the April-June quarter. The broader Standard & Poor’s 500 index dropped 11.9 percent. And the rich are once again more cautious about spending, economists say.
Those wealthy Americans went back to tightening their belts in June after months of vigorous showing. Data from MasterCard Advisors’ SpendingPulse showed luxury spending fell in June for the first time since November. The decline followed a solid rise in sales revenue earlier in the spring. “It isn’t a good omen for the consumer recovery, which cannot exist without the luxury spender,” said Mike Niemira, chief economist at the International Council of Shopping Centers.
At the same time, government reports show shoppers as a whole cut back on their spending in both May and June. Companies have responded by refusing to step up hiring. The housing market is stalling. And Americans are seeing little or no pay raises.
It adds up to a recipe for a grinding recovery to slow further. It helps explain why economists expect the rebound to lose momentum in the second half of the year. Especially if the rich don’t resume bigger spending. “They are the bellwether for the economy,” says Mark Zandi, chief economist at Moody’s Analytics. “The fact that they turned more cautious is why the recovery is losing momentum. If they panic again, that would be the fodder for a double-dip recession.” That’s because whether they’re saving or spending, the wealthy deliver an outsize impact on the economy. What’s not clear is whether they will remain too nervous to spend freely again for many months. That’s what happened when the recession hit in December 2007 and then when the financial crisis ignited in September 2008.
As their stock holdings and home values sank, the affluent lost wealth. Their jobs weren’t safe, either. Bankers, lawyers, accountants and mortgage brokers were among those getting pink-slipped. Those who did have jobs feared losing them. Neither group spent much. Instead, Americans’ savings rate spiked. And most of the increase came from the richest 5 percent, according to research by Moody’s Analytics.
Even with recent losses, household net worth has risen 13 percent from its bottom during the recession. Net worth the value of assets like homes, checking accounts and investments minus debts like mortgages and credit cards grew 2.1 percent in the first quarter. However, net worth would have to grow 21 percent more to regain its pre-recession peak. In the meantime, don’t expect the wealthy to suddenly start spending lavishly. But households chose to save the extra money rather than spend it. Higher savings restrain spending in the near term. But the extra resources allow households to strengthen their financial position.
“It is of some comfort that households now appear to have something of a cushion that can be used to pay down debt or support spending,” said Paul Dales, U.S. economist at Capital Economics. For all intents and purposes, the above statement that Dales made is truly ideal and applicable under a normal economic climate. But the kind of economy we have at this time is anything but normal. Saving for the rainy days, indeed, have its rewards. However, consumers’ spending is what is needed at this time in order to stimulate the economic recovery. And, minus consumers’ spending, there will be no economic recovery. And without an economic recovery, the Great Recession is here to stay.