The wealth effect: Americans spending up a storm

Despite threat of higher interest rates, consumers keep buying cars, jeans, and sandals - driving the economy.

The longest economic expansion in US history is sustaining - and being sustained by - a boom in consumer spending that just keeps going and going.

Call it the era of "shoppertainment." Cars, computers, clothes - virtually every category of personal merchandise in America is blowing out retailer doors.

House sales are slowing, hinting at a possible end to the party. But for now, stock-rich consumers are snapping up little somethings they've always wanted.

In fact, consumer spending is a big reason why the economy has surged despite recent Federal Reserve interest rate hikes (story, page 2).

Take the situation at Talbots. Stores of the Hingham, Mass.-based women's specialty retailer showed a staggering 20 percent increase in sales for February, compared with last year.

What's selling? Linen/cotton jeans. Microfiber trousers. Sling-back sandals.

"Everything," says Talbots spokesperson Margery Myers. February isn't typically a good month for retailers. Consumers are still exhausted from their holiday-spending labors. They're letting bank-account balances build back up in anticipation of summer vacation sprees.

This February was supposed to be particularly flat. Fed Chairman Alan Greenspan, worried about an inflationary "wealth effect" caused by stock market riches, has raised interest rates in an effort to slow the economy.

Worse, from a retailer point of view, is the sharply rising price of oil. "Gas" is a higher priority than "Palm Pilot" on most consumer shopping lists.

But a recent string of reports reveals that February spending was stronger than many analysts had anticipated.

The Lehman Brothers same store sales growth index rose 5.4 percent last month, as opposed to an expected 4.5 percent increase. The Bank of Tokyo-Mitsubishi retail sales index, which tracks 80 chains, rose 5.6 percent for the month.

The Conference Board's consumer-confidence index dipped a little bit last month, to 141.8. But it is still close to its January record high of 144.7 - and the organization's index of leading indicators rose 0.3 percent in January, to an all-time high.

"We think the outlook remains quite positive," says Lynn Franco, director of the Conference Board Consumer Research Center.

There are some soft spots in the retail economy. The biggest one is housing, the most interest-rate-sensitive purchase a consumer can make.

Last week the Commerce Department reported that new-home sales plunged 4.2 percent in January. The decline was more than three times greater than what analysts had forecast.

"Higher mortgage rates are finally slowing down the housing sector," says Merrill Lynch economist Stan Shipley.

And some analysts believe that the potential for further consumer spending has become inflationary, and thus somewhat dangerous to the economy's future health. One of the experts who believes this is particularly influential: Mr. Greenspan, chairman of the Federal Reserve.

The wealth effect

In his semiannual report to Congress on the state of US monetary policy, released last month, Greenspan has warned about a dark side of the run-up in stock prices. His logic goes like this: If investors believe US productivity will continue to go up, they will bid up stock prices in expectation of future earnings.

As those prices rise, they'll feel richer themselves. And as they feel richer themselves, watch out Porsche dealers. Investors will be snapping up Boxsters before the economy has actually grown enough to handle the new economic activity.

Got that? It's called the "wealth effect," and Greenspan figures it has added one percentage point to annual economic growth over the past five years.

Four Fed rate hikes since last June have yet to slow the economy enough to burst the wealth-effect bubble, in Greenspan's view. "Real interest rates have not yet risen enough to bring the growth of demand into line with that of potential supply," said the Fed chief in recent congressional testimony.

Thus most analysts believe the Fed will raise rates again when it meets next, on March 21. Yet many disagree with Greenspan's wealth effect analysis.

Record car sales

Take the auto industry as an example. At the top of many investor shopping lists when they're feeling happy is a new car, points out Edward Yardeni, chief economist of Deutsche Banc Alex. Brown.

Indeed, the explosion of the auto industry has been one of the big economic results of the long boom. Last month's seasonally adjusted car sales were the second-highest on record, at 19 million. "Yet car prices have been falling since mid-1997. I don't buy [Greenspan's] excess-demand model at all," says Mr. Yardeni.

(c) Copyright 2000. The Christian Science Publishing Society

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