The consumer is back. At least until he runs out of money.
Economists have been expecting shoppers to avoid the stores for a while, as they adjust to the start-of-the-year tax hikes that shrunk most paychecks and other battles in Washington that could harm the economy. But shoppers are having none of it. Retail sales in February rose by a frothy 1.1 percent from the month before, which is more than twice what economists were expecting. Compared to the same month in 2012, retail sales rose a respectable 4.6 percent.
Higher prices for gasoline explain some of the rise, but sales of cars and building supplies were strong too. The fact that consumers spent more on actual stuff, even though they were also forking over more for gas, suggests the hunker-down mentality many economists have been expecting hasn't materialized.
That upbeat news dovetails with other signs that Americans are learning to shrug off the never-ending conflicts in Washington and power the economy forward, with or without politicians' help. The stock market, for instance, has reached new highs even as Washington spending cuts go into effect and President Barack Obama warns of widespread job losses. Consumer confidence is on the upswing even though approval ratings for various branches of government are close to all-time lows.
The question, however, is where consumers are getting the money they're spending, and how long they'll continue to splurge. Incomes have been rising somewhat, so that helps sustain spending, while also boosting confidence. But there's also been a big drop in the savings rate, which suggests consumers still need to adjust their spending downward, following the increase in taxes at the start of the year.
"They may be fighting to maintain their standard of living," says economist Joel Naroff. "How long that will last is unclear."
It's encouraging that ordinary Americans seem unfazed these days by the budget battles and doomsaying in Washington. But government austerity measures will still have a depressing effect on the economy, even if it's a delayed reaction. The tax hikes on wealthy families and the end of the temporary payroll tax cut—which was effectively a tax hike on most working Americans—will take about $150 billion out of the real economy this year. The recent spending cuts known as the sequester will remove another $85 billion.
That's not a huge hit in a $16 trillion economy, but it's enough to slow GDP growth by perhaps a full percentage point and cause plenty of pain on the margins, where 12 million people remain unemployed and many others struggle to get by on inadequate pay. The payroll tax hike, while only averaging $85 per month in reduced pay for a typical worker, will still hurt low-income workers who spend every dollar.
While overall retails sales were strong in February, there were a few ominous signs that tax hikes are, in fact, causing some pain. Spending at restaurants, department stores and furniture outlets was down, for instance, which means some consumers are cutting out discretionary items they can do without.
The pain from the sequester will build too if the spending cuts aren't rescinded, with the biggest impact likely to come by early summer, when corporate profits may fall and hiring could bottom out for a couple of months. A few ugly economic reports could quickly burst the bubble of optimism that has boosted spending and stocks so far this year. The consumers may be king for now, but his reign is rather fragile.
Rick Newman's latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.