Income, spending drop despite stimulus

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By David M. Dickson

Consumer spending slowed dramatically as personal incomes plunged in July, reflecting the short-lived impact of $93 billion in economic stimulus checks.

Even as spending decreased, prices continued to increase - suggesting that overall consumption could decline in the third quarter. If consumption declines, the breadth and depth of any recession would likely be greater than the 2001 downturn, when consumption continued to grow throughout the recession.

Many economists are predicting the U.S. economy will slip into recession by the time voters cast their ballots in November.

The last two times a recession occurred during a presidential election year — 1960 and 1980 — voters replaced the party occupying the White House.

"Do not be misled by Thursday's strong second-quarter GDP report," Charles McMillion, chief economist at MBG Information Services, warned his clients Friday. "Federal, household and business debts continue to soar, and the economy's very severe troubles continue to worsen."

After adjusting for inflation, consumer spending plunged 0.4 percent in July, following a decline of 0.1 percent in June, the Commerce Department reported Friday. Consumer spending accounts for more than 70 percent of gross domestic product, making it the linchpin of the U.S. economy.

"In spite of the rapid dispersal of the economic stimulus payments in the April to July period, consumers pulled back on real spending in both June and July in the face of weak employment conditions, higher energy prices and further declines in household net worth," said Brian Bethune, chief U.S. economist for Global Insight.

On Thursday, economists at Global Insight and the U.S. Chamber of Commerce essentially predicted a recession would begin during the fourth quarter.

Nouriel Roubini, a New York University economics professor who was one of the first economists to predict the bursting of the housing bubble and the deepening and widening of the yearlong credit crisis, has been bearish on the economy since last year.

"The probability is growing that the global economy - not just the United States - will experience a serious recession," Mr. Roubini said this week. "Recent developments suggest that all [major industrial] economies are already in recession or close to tipping into one."

The official arbiter of when recessions begin and end is the National Bureau of Economic Research (NBER), a private economic-research organization based in Cambridge, Mass. NBER does not abide by the popular definition of a recession, which is two consecutive quarters of declining GDP. NBER defines a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesale-retail sales."

In 1960, a recession began in April and lasted until the following January, when John F. Kennedy was inaugurated after defeating Vice President Richard M. Nixon in a squeaker. In 1980, a six-month downturn began in January, accompanied by accelerating inflation. Ronald Reagan soundly defeated President Jimmy Carter that year.

The Bush administration hoped the economic stimulus package of tax rebates, which Congress approved in February, would stoke consumer spending as the economy slowed considerably during the fourth quarter of 2007 and the first quarter of this year. The federal government issued nearly $93 billion in tax rebate checks between April and July, but much of that money wasn't spent in stores.

"A large share of the economic-stimulus rebates wound up in personal savings accounts in the second quarter," Mr. Bethune said. "July's sluggish spending numbers indicate that consumers are reluctant to tap into those accounts under current economic conditions."

Meanwhile, inflation accelerated to 4.5 percent in July from 4 percent in June even as disposable income declined 2.6 percent in June and 1.7 percent in July - after taking that inflation into account.

Inflation has roared ahead of nominal wage gains in recent months, reducing workers' purchasing power.

While the recent decline in energy prices should reduce inflationary pressures in the future, consumers will continue to be constrained by declining home prices and rising unemployment. The economy lost nearly 500,000 jobs in the first seven months of this year.

Thus, voters may be cranky as they go into the voting booth in November.