In Twist, Nation’s Consumers Keep Spending Amid Business Cuts

WASHINGTON —  Square this: American businesses, which overwhelmingly produce for the nation’s consumers rather than for each other or for export, are behaving as if catastrophe has befallen the country. But not consumers--they are still buying at a remarkable pace.

The combination is producing a rare occurrence in U.S. economic annals: a corporate downturn without a corresponding consumer one.

Rare and, according to analysts, ultimately untenable.

“The big question is whether resilient consumer spending can help bring business back, or whether business cutbacks will weaken the consumer and bring down the economy,” said Peter E. Kretzmer, a senior economist with Banc of America Securities in New York. One or the other has to happen, he said. The two trends cannot abide.

Ominously, business Friday appeared to get the upper hand. After scores of corporate layoff announcements that couldn’t seem to lay a glove on America’s rosy employment picture, the government said the nation lost jobs in March for the first time in seven months and in the largest numbers in almost a decade.

If events repeat themselves, the country could be in for a downward spiral of rising joblessness, declining consumption, contracting production and tumbling stock prices.

But for now, people are still buying--and at rates that almost no one predicted even a few months ago.

That’s certainly true of Clint Blundon, a 35-year-old telecommunications company salesman who’s moving his wife and two toddlers from St. Louis to San Antonio and has put money down on a house.

“We’re being careful, but we’re not couponing or buying generic products,” Blundon said as he waited for a plane at Houston’s Hobby Airport. The family still plans to vacation at Disneyland.

Blundon’s behavior appears to contradict economists’ favorite explanation for the spending of the last decade--that it has largely been the product of the “wealth effect” as stock prices have rocketed and paper profits have ballooned.

The salesman has watched his retirement nest egg shrivel by more than one-third in recent months and yet he still purchased the new house.

But then, so much about the economy’s recent performance has been at odds with what analysts expected.

“It’s a flipped-around slowdown,” said James W. Paulsen, chief investment officer at Wells Capital Management in Minneapolis. “Normally, it’s the consumer who determines the ups and downs of the economy and business that follows.

“But this time,” Paulsen said, “it’s business that’s driving events by slashing capital spending and announcing layoffs.”

Will consumers follow?

According to economists, there’s a football field full of reasons why they should.

Americans have borrowed heavily over the last decade. Consumer debt as a fraction of personal income has risen to a record 85%, and consumers added another $13.5 billion in debt in February, the Federal Reserve said Friday.

They have all but stopped saving, and what easily accessible financial assets they have are shrinking fast. According to Moody’s Investors Services, household liquid assets--savings and other accounts that can be quickly converted to cash--were 13.2% smaller in the first three months of the year than in the same period last year.

And they have taken a bath in the stock market. As measured by the Wilshire 5000 Index, more than $5 trillion of paper wealth has evaporated since the market peaked last spring, about one-third of the gains since the market took off in the mid-1990s.

“People don’t mark their net worth by the minute or the month or the quarter,” said Edward F. McElvey, senior economist at Goldman, Sachs & Co. “But it’s hard to imagine wealth losses like these not having an effect.”

Perhaps. But Megan Hall doesn’t plan to change her spending habits, despite watching the value of her children’s college funds tumble and predicting that the economy “will probably get a lot worse before it gets better.”

“My husband and I both have secure jobs,” said Hall, a mother of three who works for a Seattle real estate firm. “I think we can ride it out.”

And no changes in spending are in the plans of Michael Warren, who has most of his savings tied up in his commercial cleaning company in suburban Atlanta. Warren has seen no falloff in business. “If anything,” he said, “it seems to be going the other way.

“For the low-tech, small-town sector, so far, so good.”

Economists always worry about consumers because they are the biggest spenders around, accounting for more than two-thirds of expenditures on the nation’s gross domestic product.

“If American families were to trim their spending by just 1% this year, that would represent the biggest decline in consumption since World War II and have a nasty effect on growth,” McElvey said.

And analysts are especially concerned. Consumers’ role is all the more important as corporate America slashes its own spending in a drive to salvage profits and stock prices.

To the extent that there’s a pattern among consumers, interviews around the country in recent days suggest it is that people view their remaining stock market wealth as something to be used in retirement or in the distant future, rather than as an influence on their current spending.

Asked to describe his current lifestyle and say whether he planned to make any changes, Bill Pruitt, a 37-year-old Chicago medical supply company official, answered this way: “Like to eat out with wine or at home with Pepsi and franks? I do both. I am not going to buy cheaper hot dogs.”

Besides hot dogs, consumers recently showed they are not ready to buy cheaper--or fewer--houses or cars.

Although new and existing-home sales dipped in February, they were still running at annual rates well above the average for 2000. During the first three months of the year, Americans snapped up cars and light trucks at a pace of better than 17 million a year. If maintained, that would make 2001 one of the best sales years ever.

Sustained buying in the face of recent stock market declines seems to fly in the face of the wealth effect that economists so often cited in explaining most of the growth of the last decade.

But that doesn’t mean the effect doesn’t exist, said Paulsen, the Wells Capital economist. It just hasn’t played as important a role where analysts have most often looked for it--among American households.

“The wealth effect occurred,” Paulsen said, “but in the corporate sector.”

Since 1990, stock prices have become the measure of corporate success, he said. When prices were rising, corporations expanded like mad. Now that they are declining, “the corporate sector is shutting down.”

Paulsen and others believe that virtually every aspect of the slowdown to date--especially its abrupt arrival and its focus on technology--can be traced to corporations rather than consumers.

“We may be experiencing the first post-war slowdown led and directed more by the business sector than households,” Paulsen said.

If he is right, the slowdown could be considerably longer than many people, including Federal Reserve policymakers, expect. That’s because traditional economic medicine like interest rate cuts could have little effect on companies that have expanded too much. As Paulsen put it: “Who wants to borrow if there is already overcapacity?”

The slowdown also could be considerably deeper than expected if companies seek to placate investors and protect their stock prices with layoffs.

In this regard, the next few weeks could prove crucial as firms announce their profits for the first quarter of the year and decide whether to couple the news with pink slips.

*

Researchers Edith Stanley in Atlanta, John Beckham in Chicago, Lianne Hart in Houston, Anna M. Virtue in Miami and Lynn Marshall in Seattle contributed to this report.