Silver lining of shrinking economy: consumer spending up

Economic activity in the US plunged 6.1 percent in the first quarter of this year, but free-fall in consumer spending stopped.

Economic activity in America plunged again in the first quarter of the year, but positive signs in one key indicator – consumer spending – could foreshadow economic stability later this year.

Overall, the nation’s output of goods and services declined at an annual rate of 6.1 percent in the period of January to March, according to preliminary numbers released Wednesday by the Commerce Department. That was almost as bad as the fourth quarter of last year, but the report showed a crucial difference.

Where consumer spending tanked in the fourth quarter, it held up in the most recent period with a 2.2 percent annualized gain.

That sign of resilience was punctuated earlier this week, as a separate survey released Tuesday showed a solid rise in consumer confidence.

The implication, many economists say, is that the second quarter should see a smaller drop in gross domestic product (GDP), with stabilization or modest growth improvement after that.

“Probably the worst is behind us in terms of rates of decline,” says Jay Bryson, an economist at Wachovia Corp. in Charlotte, N.C. “Certainly by the fourth quarter I would think you’re going to start getting some positive growth numbers.”

A US recession was already well under way by last fall, but it accelerated as turmoil in financial markets caused an unusually sharp pullback in consumer activity.

Consumer spending fell at a 3.8 percent pace in the third quarter and a 4.3 percent pace in the fourth quarter.

Since consumer spending represents about two-thirds of GDP, the turnaround so far this year could signal a welcome transition for the whole economy out of panic mode.

It’s not that Americans are going hog-wild for new houses or Harley Davidsons, however. In the first quarter, shoppers were buying goods at a pace that was still down when measured against the beginning of 2008.

But, compared to the previous quarter, their spending rose at an annual rate of above 2 percent.

“Perhaps that’s starting to stabilize,” Mr. Bryson says. “It all really depends, at the end of the day, on what happens to real disposable income.”

Rising unemployment rates represent a hit to personal incomes, but Bryson notes that spending power is being buoyed now by modest new tax cuts and cooler inflation. Falling energy prices acted as a kind of income boost for the first quarter of 2009, for example.

Barring a new hit to the economy (he cites the current need to control swine flu), Bryson expects that consumer spending will continue to rise this year and next, albeit at a more temperate pace such as 1 percent.

The potential for households to add to GDP is constrained by the decline in personal wealth during the recession. For many families, lost wealth in home values and retirement accounts means that a priority now is to pare debt, control spending, and rebuild savings.

Still, in the first quarter Americans were able to expand their savings rate even as they boosted spending. Savings rose to 4.2 percent of overall disposable income, more than double the savings rate in 2008 and far above the prior two years.

Meanwhile, the modest rise in consumer spending helped investors to see some hope, despite the overall GDP decline.

“Recovery can occur as over 90 percent of workers are employed, and their spending can move the economy forward in the second half of this year,” Dallas economist Michael Cosgrove writes in a new edition of his market newsletter, The Econoclast.

Stock indexes rose modestly Wednesday morning, following the release of the economic numbers.

Even as consumers held their own, the GDP report showed sharp declines in other areas of the economy, especially business investment. Firms put expansion plans and other purchases on hold as they waited for clearer signals on the economy’s direction.

Also, businesses slowed production of goods as they tried to work through excess inventories.

Even though these business investment and inventory activities are a much smaller share of overall GDP than consumer spending, the retrenchment by corporate America was so sharp that it outweighed the gains in consumer activity.

That was the main reason for the drop in GDP. Government spending also fell, due to a drop in state and local government outlays and in federal military spending.

If consumers are setting the stage for a turnaround in GDP later this year, that doesn’t mean a quick rebound in one key barometer of the economy, the job market. Typically, unemployment keeps rising even as a recession bottoms out.

Several burdens on the economy could make it hard for employers to begin rehiring at a rapid clip: the tepid pace of consumer spending, the global scope of the slowdown (affecting demand for US exports), and a tougher credit climate.

Even with the March rise, the consumer mood remains very low, even compared to the last two recessions.

Thus, what’s happening now may be small steps toward a slow economic recovery.

Along with the consumer progress, other steps include:

• Confidence of corporate chief executives improved modestly in March, according to Chief Executive magazine.

• The Federal Reserve has expanded the supply of money available as fuel for growth.

• Credit markets have shown some signs of stabilization, aided by support from the Fed and Treasury Department.

• The large fiscal stimulus signed by President Obama this spring is ramping up, offering a boost from government spending this year and next.