A few years ago, our shopping binges seemed permanent. We bought stuff constantly and borrowed to pay for it even if we didn't have the cash. But these days, we go on mini binges--then abstain for a while.
Shoppers have flexed their muscles over the last few months of 2011, with holiday sales likely to show a respectable 5 percent gain over 2010 levels, according to forecasting firm IHS Global Insight. Consumer optimism has improved, even though unemployment is still high and Washington politicians have descended to new levels of ineptitude on managing the economy. Just six months ago, economists thought there was a 50-50 chance we'd be in another recession by now. But buoyant consumers, spending more than expected, have kept us out of a dreaded double-dip.
In a way, this is what the economy used to feel like: Consumers shopped as if there were no consequences, and consistent spending kept business brisk at most companies, and jobs plentiful. But the consequences of spending—or rather, overspending—are far more tangible today. And shoppers seem poised for a substantial breather. "We are particularly skeptical about a consumption rebound," Bank of America Merrill Lynch warned its clients recently. "The consumer is in a long period of rehab."
Consumer spending still accounts for roughly two-thirds of all U.S. economic activity, so a spending pullback in 2012 would slow overall growth and prolong all the familiar problems, including scarce hiring and a housing bust now in its sixth year. Another U.S. recession seems unlikely—barring unforeseen shocks—but a weak recovery will continue to feel like a recession to many Americans. Here are four reasons why consumer spending is likely to fade:
Incomes aren't rising. Over the last two years, spending and income mostly moved in the same direction, and for a while income rose by more than spending, which meant people were saving more. But in mid-2011, the opposite started to happen: Real income, after accounting for inflation, fell, but real spending rose. That happened for two reasons: Consumers have been saving less, and borrowing more to finance purchases.
That's partly a return to old "normal" habits. The problem is that many consumers aren't yet ready to get back to normal. The typical household still has about $21,000 in consumer debt, including credit card balances and car and student loans. That's about 6.4 percent lower than the peak level of consumer debt in 2008. But it probably needs to fall a lot more.
Most people's net worth has fallen over the last four years, on account of the housing bust and a drop in stock values. Perhaps half of all baby boomers are poorly prepared for retirement, and need to save more. And many younger consumers have loads of student debt and weak job prospects. Consumers did save more of their income during the recent recession, but the savings rate has now fallen from 6.2 percent in 2009 to 3.8 percent. "Consumers are unlikely to keep saving at such a low rate," says economist Scott Hoyt of Moody's Analytics. "The Great Recession made clear the danger of relying on household assets to support spending." If people start to save more, as Hoyt and many others expect, spending will fall.
The European crisis will cut into wealth. The European debt crisis, now entering its third year, has become a kind of unpleasant background noise that U.S. consumers have learned to tune out. But it may become impossible to ignore in 2012, when one of several precipitating events could force an endgame in which Europe either finds a way to prop up struggling economies like Italy and Greece, or they leave the euro zone, which would probably prompt a severe financial crisis.
Many analysts think it will take a near-catastrophe to generate the political will required to finally force a definitive outcome. If so, it will mean a rough time for stocks and an even more anxious climate for investors than we've seen in 2011. If Europe finds a workable way through its debt problems, the ultimate result could be a healthier global economy and a more buoyant stock market. Before that happens however, a sharply falling stock market could spook investors, create the impression that another recession is nigh, and depress spending in both Europe and the United States.
The recent binge has been fueled by temporary factors. One of them is a decline in gas prices, which have drifted down 70 cents or so from a peak of about $3.90 per gallon earlier this year. That affects consumers in two ways: It makes them feel better about spending, and it puts a bit of extra cash in their pockets. Gas and oil prices could stay where they are or drift even lower, but they could also spike for any number of reasons, which would unnerve shoppers in the usual way. Car purchases have been another contributor to recent spending gains, which may indicate that consumers are more comfortable making big purchases, but might also reflect pent-up demand resulting from the Japanese earthquake and a six month shortage of some cars that is finally being rectified. It's not clear yet whether car sales will continue to pick up, or fall back to earlier, depressed levels.
Another temporary factor contributing to robust spending may be forced defaults on credit-card balances from earlier in the year. That's hardly a sign of financial health, but it does wipe out debt and leave some consumers with more money to spend—for a while. And most workers got a modest tax break in 2011 that now seems likely to expire, taking an additional $1,000 in taxes out of the typical paycheck in 2012. With Uncle Sam getting more, consumers will spend less.
Some shoppers may not even realize they're spending more. Part of that 5 percent holiday spending increase is due to inflation, which has run at about 3.4 percent over the last 12 months, a higher rate than the prior three years. So people are spending more for the same amount of stuff. There's also been a 10 percent spurt in spending on medical care over the last year, which may skew the overall spending numbers upward in ways that don't accurately reflect how consumers intend to spend their money. So as the final bills from 2011 start to arrive, shoppers may realize they've overspent, and decide, once again, that it's time to stow their wallets. For every binge, there is now a purge.