AFTER TWO PAINFUL YEARS of retrenchment, American consumers are flexing their wallets again. They have paid down debt, boosted their savings and otherwise strengthened their personal balance sheets since the recession hit with terrifying force in the second half of 2008.
As a result of their improving circumstances, the nation's merchants are likely to enjoy a jolly holiday season, with retail sales up 3.5% to 4%, exceeding both last year's meager 0.4% gain and expectations of 2.3% growth forecast by the National Retail Federation. More important, the consumer-dependent U.S. economy could grow by as much as 4% in 2011, well ahead of the current consensus estimate of a 2.4% increase in next year's gross domestic product. Consumer spending accounts for more than 70% of GDP, although that figure includes government spending on health care.
Look almost anywhere these days, and the data paint a picture of household finances on the mend. After three years of deleveraging, total U.S. consumer debt has falln by roughly $1 trillion, to $11.58 trillion, from a peak of $12.5 trillion in the third quarter of 2008, according to data from the Federal Reserve Bank of New York. In particular, credit-card debt has shrunk by 16%, to around $730 billion, and auto loans have fallen about 12%, to $710 billion.
Moreover, household financial obligations—defined as debt and lease payments, rent, home insurance and property taxes—have fallen to 17% of disposable income, down from an all-time high of 18.9% in the third quarter of 2007 and below the 30-year average of 17.2%, notes James Paulsen, chief investment strategist at Wells Capital Management.
In a further sign of consumer retrenchment, U.S. discretionary spending has fallen to 50-year lows as a percentage of total consumer spending, notes Steven Wieting, U.S. economist at Citi Global Markets. The decline began when the dot-com bubble burst in 2000, but accelerated with the onset of the financial crisis in 2008.
Collectively, sharp cutbacks in debt and discretionary spending, along with lower interest rates and potentially good news on taxes, suggest the U.S. consumer isn't quite as tapped out as some economists fear. Rather, consumers have more spending power today than they have had in a while, which, together with improvements in the equity market, could boost retail sales, and help shoppers satisfy long pent-up demand.
The stock market, at least, has been anticipating an end to the deleveraging process. Propelled by news of rising sales and earnings, retailers' shares have rallied in recent months, and the Standard & Poor's 500 Retailing Index is outperforming the broader S&P 500 by nine percentage points year to date. "I have a lot of faith in the consumer's demand for goods and services," says Wells' Paulsen. "I don't think we've killed that off."
Paulsen expects household debt to "bottom out and start turning up next year," as the recovery blossoms. Noting that fears of a double-dip recession have faded and leading indicators have risen, he expects the economy to grow by 3.5% to 4% next year.
MANY ECONOMISTS, on and off Wall Street, project substandard GDP growth of 2% or less in coming years—what Pimco's Bill Gross calls the "new normal"—and some expect the consumer to remain an endangered species. For openers, they note that total household debt, though down from its peak, is up by more than $6 trillion in the past decade. Equities and real-estate investments, on the other hand, have lost 23% of their value since peaking at a combined $37 trillion in 2006. An aging population also could be a drag on future spending.
Nor has deleveraging been a speedy process in the past, as economists Carmen and Vincent Reinhart reminded readers in "After the Fall," a paper they published in August. According to data the Reinharts assembled, in the decades following past financial crises since the Great Depression, GDP rates have risen only 1% and unemployment in developed economies has been about five percentage points higher. The process of deleveraging has taken an average of seven years.
"The decade that preceded the onset of the 2007 crisis fits the historic pattern," they wrote. "If the deleveraging of private debt follows the tracks of previous crises as well, credit restraint will damp employment and growth for some time to come."