Consumer spending drops record 2.8 percent

Even without plunging auto and gasoline sales, October's rate was still -0.5 percent – a gloomy sign for holiday shopping.

With only two weeks to go before the holiday shopping season kicks off, consumers don't appear to be in the mood to spend.

Who can blame them?

Credit remains tight, job losses are spreading at an eye-opening rate, and home prices are continuing to fall. When consumers pick up the paper they read that the economy is in a recession. About the only bright spot is the price of gasoline, which continues to fall as consumers stay home and watch football games instead of heading to the mall.

Some economists expect the deepening consumer malaise to be one of the factors that pushes the Federal Reserve to drop interest rates next month after lowering short-term rates to 1 percent at the end of October. In a speech on Friday in Frankfurt, Germany, Fed Chairman Ben Bernanke indicated that the Fed would take additional steps if needed.

The latest indication of how tightly consumers have shut their wallets came on Friday when the Commerce Department reported that retail sales in October fell 2.8 percent. That's the biggest one-month drop since at least 1992, when the department changed the way it reports the numbers. The decline was led by a 5.5 percent drop in auto sales, as potential car buyers either could not get loans or just stayed away from showrooms.

"This is a bad precursor to the holiday season," says Bob Brusca of Fact and Opinion Economics in New York. "You have to be worried about demand collapsing in October ahead of the holiday season when the bulk of retail activity occurs."

Even eliminating the problems of selling cars and the effect of lower gasoline prices, retail sales still fell 0.5 percent in October. "What we are worried about is a change in spending patterns," says Scott Brown, chief economist for Raymond James & Associates in St. Petersburg, Fla. "A lot of people are not that much affected by the job losses or changes in the economy, but they are scared and are adjusting their spending."

Some of the adjustments are starting to show up in the way people are shopping, says Dennis Jacobe, chief economist at Gallup Inc. in Washington. In surveys of consumers, Gallup is finding that the lower gasoline prices and the election of Barack Obama to the presidency have made lower- and middle-income wage earners more optimistic. "But that is offset to some degree by the jobs situation and the credit crunch for the average American," he says.

More importantly, he says, Gallup's surveys show that upper-middle and upper-income people are more pessimistic. "Partly, it's the continued deterioration of housing values and their stock-market wealth," he says. "But on top of that, the credit crunch hurts more because they borrow more."

Mr. Jacobe says higher income individuals are now starting to shop in stores such as Target or Wal-Mart. On Thursday, Wal-Mart, reported third quarter sales rose 7.5 percent and profit increased 9.8 percent. At the same time, other more upscale retailers, such as Starbucks and Best Buy, have reported less impressive results.

"When Obama takes office, he might have to consider ways to stimulate upper- and upper-middle-income spending," says Jacobe.