Only consumers can turn rally hopes to reality

“Let the good times roll … You gotta go out and spend some cash … I don’t care if you’re young or old … let the good times roll.” So advised blues singer BB King in the 1990s. Whether it is good advice today depends on how you read some complicated data.

Most consumers will look at last week’s jobs report, showing that the unemployment rate rose from 9.4% to 9.7%, the highest level since June 1983, and shudder. Economists will look at another part of that report: job losses in August were 216,000 (198,000 in the private sector), well down from the average monthly loss of almost 700,000 in the first quarter of the year, and the 421,000 in the second quarter. If the improvement continues, the jobs market might level off by year-end.

There is reason for optimism. “Global economy gains steam”, said The Wall Street Journal. “Profits perk up at large US companies”, said Business Week. “Data generally consistent with early recovery”, Goldman Sachs told its clients.

After well over a year of decline, the manufacturing sector is picking up.

For the first time in 18 months, the Institute of Supply Management said that its August index topped the 50 mark that divides shrinkage from growth. Executives in some 11 industries said new orders are coming in, sales are up, and the prices they can get are rising.

Throw in an improvement in home sales, in durable-goods orders, business’s need to rebuild inventories, the fact that most of the $787 billion stimulus money will hit the economy in the last quarter of this year and some time in 2010, and we can look for continued improvement in the jobs market.

But not with complete confidence. For one thing, it is not clear that consumers are prepared to “go out and spend some cash”. August back-to-school sales were off about 3%. Consumers bought only necessities and resisted any attempts by retailers to end the era of deep discounting. Retail sales of women’s clothes (except shoes), household goods, and even electronics were down in August from a year earlier for the twelfth consecutive month. Retailers fear this bodes ill not only for the Christmas season, but for the much longer term.

Low and middle-income consumers are still paying off credit-card debt, and upper-income Americans are trying to rebuild the wealth that was wiped out in the stock market and property declines.

Whether this tight-fistedness will continue when the job market improves and incomes begin to rise, nobody can tell, but pessimists see a cultural shift to thrift that will affect consumer behaviour far into the future. Which is not entirely bad news: an economy that moves from a negative savings rate to a more normal situation in which consumers save between 5% and 7% of incomes is likely to have lower interest rates and higher levels of investment.

Keep this in mind: nobody has ever got rich by betting against the American consumer. We may be witnessing a shift in purchasing habits rather than a permanent decline in the inclination to spend. Fashion specialist Nordstrom saw August sales drop 3% from last year, and upmarket department-store chain Saks experienced a plunge of more than 20%. Perhaps most significantly, Abercrombie & Fitch, the retailer that has tried to avoid price cutting and promotions, saw a drop of almost 30%. However, the price-cutting and bargain-offering chains Ross Stores, Costco, Target, Old Navy and TJ Maxx surprised analysts by doing better than expected.

“It’s really still a discounter’s and an off-price seller’s market,” said Ken Perkins, president of the research firm Retail Metrics.

A more immediate problem is the condition of the commercial property market. There are some $700 billion of commercial mortgage-backed securities out there, and by the end of 2012 some $153 billion of those will come due. Deutsche Bank estimates that $100 billion of those will not have an easy time getting refinanced. Worse still, banks are holding $1.7 trillion — yes, trillion — in commercial mortgages and construction loans, and the delinquency rate on these is already so high that the Federal Deposit Insurance Corporation added 111 banks to its list of “problem banks” in the last quarter, bringing the total to 416, about 5% of all American banks. These problem banks have combined assets of $300 billion.

Perhaps the best summary of the current situation is that we are back from the brink, the economy is improving more rapidly than many expected, but continuing problems in commercial-property and job markets, and consumer nervousness, leave the economy “still vulnerable to adverse shocks”, as members of the Federal Reserve Board’s monetary policy group put it.

Where we go from here will be determined in part by the outcome of the G20 meetings. The finance ministers meeting this weekend in London cleared the way for their leaders’ meeting in Pittsburgh later this month, with Barack Obama presiding. The assembled leaders will have two main chores. The first is to come up with some plan to reform the financial sector. The Americans want to increase the amount of capital banks must have to back their loans, the French are more concerned about reining in bankers’ pay, and the Germans want to make sure that no bank gets so big that it can, in Chancellor Angela Merkel’s words, “blackmail governments”, which puts her in the camp of Britain’s Lord Turner, whose policy proposals are moving in a similar direction.

More important for the sustainability of the recovery will be the development of a co-ordinated strategy for winding down huge government deficits and pulling back the extra cash that has been pouring off the world’s printing presses. With the Obama administration unwilling or unable to staunch the flow of red ink, it falls to Fed chairman Ben Bernanke to lead the world in heading off inflation by withdrawing cash and tightening credit. He knows that. He just doesn’t yet know when to begin that politically unpopular process.

Stay tuned.  (Irwin Stelzer, The Sunday Times)


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