IHT : Warning signs and defining economic moments

Warning signs and defining economic moments

By Vikas Bajaj and Jeremy W. Peters | September 14, 2007

When Annie Cox is unsure if the economy is headed south — a question on the minds of many on Wall Street and Main Street these days — she keeps an eye on the orders for beverages at the diner she runs in Oklahoma City.

In recent weeks, Cox said she had seen a slight drop-off, leading her to believe that business could slow in coming months. "When they start ordering water instead of tea or Pepsi, that means they're cutting back," said Cox, who runs the 1950s-style restaurant, Sherri's Diner, that is named after her mother.

Leon Tuberman, the chief executive of the Barn Furniture Mart in Southern California, is similarly wary. Despite widespread troubles in the housing market, business is down only about 5 percent. But Tuberman said he was not replacing the five employees who left the store voluntarily in the last six months, because he suspected that spending would remain sluggish.

Across the nation, the impact of the turmoil in the housing and credit markets on the broader economy has been relatively modest so far. But just as some of Cox's customers are becoming more cautious and Tuberman is holding back on hiring, many people are preparing to hit some economic headwinds.

Whether that caution on the part of consumers and business translates into little more than a modest economic slowdown or turns into a full-blown recession will depend on a variety of factors. But perhaps the most important are whether jobs remain plentiful and consumers keep spending.

That is what was so ominous about the government's report last week that businesses reduced total employment by 4,000 jobs in August and that payroll gains for previous months were being lowered. Another important labor market indicator — the share of the working-age population that reports holding a job — has fallen to its lowest level in nearly two years. And consumer spending, while it continues to grow, has slowed in recent months.

"Large numbers of people are leaving the job market," said Jan Hatzius, chief United States economist at Goldman Sachs. "That is not just a sudden bout of laziness, but it's a response to reduced labor market activity."

Hatzius and his peers on Wall Street now put the risk of a recession at about one in three, which is significantly higher than earlier this year but far from a sure thing.

They note that in recent years consumer spending was led higher by the torrid boom in housing, especially in big states like California, Florida, Arizona and New York. Now, as home prices fall, loans are harder to get and home equity borrowing is tapering off. As a result, consumer spending is likely to suffer.

Those downward pressures, though, are being offset by a robust global economy that is providing a significant lift to exports, corporate profits and real wages, which finally picked up in the last year after stagnating for much of the decade. Optimists note that consumer spending is unlikely to slow as long as hourly wages are perking along at a nominal annual pace of about 4 percent, about 1.5 percentage points above the inflation rate.

"There clearly is a problem in mortgages," said David Kelley, an economist at Putnam Investments, the mutual fund company in Boston. But "outside the mortgage market, we don't really see the consumer stopping spending."

Consumer spending has often defied dour predictions. There was no decline in spending during the recession of 2001, even as job losses mounted and business sentiment sank after the technology bubble burst. That is one reason the downturn was so mild compared with the harsher recessions of the early 1980s and early 1990s.

Economists also note that spending by higher-income consumers has a far more significant impact on the economy than purchases by those who are less well- off, a group that appears to be most vulnerable to declining home prices, resetting mortgages and job loss.

"There are essentially two consumer economies right now, and they parallel the split between the very rich and everybody else," said J. Walker Smith, president of Yankelovich, the consumer research firm based in Norwalk, Connecticut "There is one part of the consumer economy that is unlikely to be affected at all by the recent events in the financial markets. Those are the people making the loans. The people taking the loans, however, are the people who are affected."

Tuberman sees that bifurcation in his furniture business.

Even as a number of competitors and distributors have gone out of business, Barn Furniture's sales have held up, he says, because it receives most of its orders from repeat and longtime customers, who are drawn to his traditional wood products.

But new customers are hard to find.

"When someone refinances a home and they have extra money, they buy new furniture; when somebody buys a new home, they buy new furniture," said Tuberman, whose family has run the store since the 1940's. "When their adjustable-rate mortgage just increased by 40 percent, they don't buy furniture."

The downturn in housing is visible far and wide. Tex Pitfield, who owns a petroleum distributing business outside Atlanta, says he is not renewing the leases on 4 of his 20 trucks because business has slackened, especially in areas directly connected to residential real estate.

"We are not running any fuel to the construction companies for new home sites, the guys that put in the sewer lines and the utilities," he said. "Big block stores are down in consumption and retail consumption is down."

Some of that may be related to rising energy prices — oil prices this week topped $80 a barrel and the average price of gasoline nationally is $2.81 a gallon, up about 20 cents from a year ago, according to the Energy Information Administration.

In much of the country, Americans cannot change their driving habits easily or in the short term. But consumer behavior experts say gas prices could force people who may already be stretched thin by debts to cut back. Families facing a higher house payment or the loss of a job will probably go out less, buy fewer clothes or spend less on entertainment.

"From one week to the next, to fill up your car could cost $30 or $50 — and for a lot of families, that's either the cable bill or a night out to eat," said Phil Rist, executive vice president of BIGresearch, a consumer research firm in Worthington, Ohio. "The fact that they don't know where gas prices are one week to the next, that creates trepidations."

Smith of Yankelovich echoed the sentiments of Cox in Oklahoma City in highlighting how consumers may change their spending: "Some of our restaurant clients joke that they know when the economy is starting to head down by dessert sales," he said.

Consumers always start by eliminating the purchases they see as unnecessary. "They begin to eat out differently. They eat out less. Often they trade down to lower-priced restaurants. And they quit buying all the extras like dessert."

For her part, Cox is confident that her business will survive even if customers stop buying dessert. After all, she's seen worse.

"We made it through the last two recessions just fine," she said. "You just have to be resourceful."