No stopping the shopping for US consumers

[DevilDog#1]

The global economy depends on the cash register, writes Christopher Swann
January 23, 2006

ROBIN Williams, the American comedian, once said that cocaine was God's way of saying you are making too much money. As yet, there is no accurate official measure of spending on the drug, but you do not have to look far for evidence that US consumers have been awash with cash in recent years. Compared with five years ago, Americans are spending 25 per cent more at Las Vegas casinos, 78 per cent more on breast implants and 40 per cent more on sporting events.

For more than a decade, American shoppers have been the most reliable support for the economy, increasing their spending by at least 2.5 per cent every year in real terms since 1992. After such a run, economists are understandably reluctant to bet against the indefatigable US consumer. But many are starting to wonder whether 2006 will mark the end of this heroic spending spree.

The past year, in particular, has started to stretch American households. Caught out by rising energy prices and lacklustre pay increases, Americans might have been expected to rein in their spending. Instead, for the first time since 1933, they dug into savings in 2005, spending around $US41 billion ($54.8 billion) or 0.5 per cent more than they earned.

When the complete figures for the year are released, they are expected to show that Americans saw their real disposable income rise by just 1.3 per cent over the year but increased real spending by 3.5 per cent.

US household debt has reached $US11,400 billion, an unprecedented 126 per cent of annual disposable income. When interest rates were at record lows, financing such debt posed little problem. As rates have risen, however, the burden is starting to become more onerous. The Federal Reserve says the cost of debt servicing has climbed close to record highs -- almost 19 per cent of disposable income.

Yet, there has been surprisingly little sign of financial strain. Late payments of consumer loans are actually down over the past year. Delinquencies for mortgages are still at half the level reached at the end of 1991.

Most economists attribute this resilience to the rising value of the assets Americans own -- especially their houses. Americans may have had a poor year in terms of pay rises but they are wealthier than ever.

The net wealth of Americans, even after taking into account the large rise in debt, has risen by around $US5000 billion over the past year to $US51,000 billion. They are around $US8400 billion better off than they were five years ago. "If American consumers were grouped together as a company, they would have had a very weak profit and loss account in 2005 but the balance sheet still looks in splendid shape," said Eric Britton, an analyst at Oxford Economics.

This leads to the first potential problem for US consumers. Much of their new wealth has been built up in the housing market. If this starts to weaken, it will pull the rug from under many Americans.

"Most consumers have come to believe that house price rises are now part of the US constitution," said Ms Williams. "People have been using their homes like an ATM machine, withdrawing cash by refinancing in order to supplement their wages."

A mere flattening out of house prices could be enough to sober up the US consumer and dramatically reduce equity withdrawal. Research by the Federal Reserve suggests that Americans extracted around $600 billion from their housing equity last year and spent about a quarter of that. Without this boost, it is likely that real spending growth would have been close to 2.5 per cent rather than an estimated 3.5 per cent.

The second risk for consumers in 2006 is that wage growth remains weak. With unemployment at just 4.9 per cent, workers should have the bargaining power to push wages higher. This has yet to happen and some economists worry that 2006 will be another poor year for pay. The participation rate in the US is still well below its peak -- suggesting there may be many marginal workers ready to enter the labour market, helping to keep wages under control. The threat of moving production overseas may also aid companies taking a hard line on wages.

The third threat comes from interest rates. Even with rates at low levels, Americans spent a record share of their disposable income in interest payments. The cost of servicing debt is likely to increase still further. "The full impact of monetary tightening from the Federal Reserve has not yet fed through into the economy," says Nigel Gault, head of US research at Global Insight.

"This might take 12 months or more as mortgage rates fixed for certain periods are allowed to rise."

An increasing number of Americans have opted for adjustable-rate mortgages rather than 30-year fixed-rate loans. This will make them more vulnerable as rates rise.

Few economists are expecting a dramatic weakening of consumer spending over the coming year. But the risks are rising.

Something big is needed to get Germans shopping and kick-start the continental European economy. Georg Lackner thinks it is woolly mammoths. The director of the NordWestZentrum shopping mall outside Frankfurt says the installation of life-size replica hairy beasts along his centre's shiny boulevards "should encourage people to come from quite a way to see them -- we, of course, hope to increase our turnover".

His inventiveness may pay off. Consumer confidence in Germany, which is Europe's largest economy and accounts for almost one-third of eurozone gross domestic product, is at the highest level for more than three years, according to the European Commission. Christmas trade at NordWestZentrum was "clearly better than last year", says Mr Lackner, and post-Christmas business has been brisk.

Shopping centres have fared better than other German retail outlets in recent years. But signs of the general improvement in retail sentiment have been seized on. If translated into a spending revival, the effects would be large for the 12 countries that since 1999 have shared a currency. For five years, the eurozone has been on a sluggish growth path. Dragged down by Germany, the Netherlands and Italy, consumer spending has underperformed that in the US and Britain.

In France, private consumption has remained brisk thanks to government initiatives, the availability of credit and the willingness of French consumers to save less, even in difficult economic times. But a pick-up in German demand would herald a significant brightening of eurozone economic prospects, beyond the largely export-led growth of recent years. "The biggest story is about those countries where consumer spending has not contributed to growth, but might," says Jacques Cailloux, an economist at JP Morgan.

Reviving German consumer spending nevertheless remains a gigantic task. Household expenditure has hardly increased in the past four years; the federal statistics office reported it did not grow at all in 2005.

German reluctance to spend reflects severe downward pressures on wages and the huge economic uncertainty created as politicians have sought to reform an expensive welfare system and companies have pushed through cost-cutting plans.

Fears that European governments have reneged on contracts to provide for consumers' old age have simply heightened the propensity to save.

The gloom may be lifting a little. The new Government of Angela Merkel looks stable even though the Chancellor heads a cumbersome "grand coalition" of social and Christian democrats. Employment prospects show signs of improving.

The Berlin administration may also have been shrewder than some think. Its plan to increase value added tax by 3 percentage points next year has prompted consumers to bring forward durable goods purchases, NordWestZentrum retailers say.

However, no one expects an overnight cultural change. "You won't make a south Italian out of a German," says Klaus Wubbenhorst, head of the GfK consumer research group in Nuremberg, although he points out that even a modest rise in spending would have a large effect in Europe simply because of Germany's size. The football World Cup that Germany will host this northern summer should boost television sales and, depending on results, instil a party spirit, but "Germans are the savings champions of the world".

The country's private households paid back more than they borrowed for the first time in 2004, according to the Bundesbank -- despite interest rates at record lows. From a US or British consumer's perspective, the attitude towards buying on credit cards is prehistoric: German banks generally only issue so-called credit cards on the assumption that sums outstanding will be paid off each month.

The eurozone propensity to save is unlikely to drop much. Consumers have saved in excess of 14 per cent of their gross disposable incomes in recent years, compared with about 1 per cent in the US. Recent European Commission research concluded that the apparent implication of demographic trends is that the euro area should now be entering a golden age of saving as the post-war baby-boomers move through middle age.

Instead, eurozone consumer spending, especially in Germany, will remain highly correlated to disposable incomes -- more so than in the US or Britain, where differences in financial systems and behaviour increase the importance of consumer credit and house prices.

The trend in the eurozone, however, has been for growth in disposable incomes to slow. In the 1980s, disposable incomes rose at an annual average rate of 2.3 per cent. That fell to 1.6 per cent in the 1990s and has dropped to 1.4 per cent since 2001.

Additional reporting by Ralph Atkins, David Pilling and Scheherazade Daneshkhu

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