The Newly Frugal American Consumer

Consumer spending drives the U.S. economy.  In fact, it accounts for about 70 percent of GDP.  While the dramatic inflation in food and gasoline prices that started in 2005 has begun to abate, four factors continue to rattle the confidence of American consumers and convince them to keep their wallets and purses closed: 

• The continuing slump in the housing market that is lowering the equity in their homes.
• The stock market decline that has wiped out a chunk of their retirement portfolios.
• A tight credit market, which limits their ability to borrow money to pay for big-ticket items.
• A shrinking job market, with unemployment reaching a five-year high of 6.5 percent in August, compared to under 5 percent one year earlier.

Not surprisingly, consumer confidence fell to a record low in October 2008.  The Conference Board's index fell from 61.4 in September to 38.0 in October, the lowest reading since the index was started in 1967.  One year earlier, the figure was 118.¹

Because of the housing and stock market downturns, U.S. household net worth plummeted by $6 trillion in the first three quarters of 2008, or about 11 percent.  Of all of the economic factors, the most widespread and disturbing is the housing slump.  According to a Bloomberg² report, this "negative wealth effect" has had a measurable impact on consumer spending this year. 

Economists at the University of Southern California and UCLA calculate that a 10 percent decrease in the value of American homes has caused a $105 billion drop in personal spending.  That's a decline of 1.2 percent. 

Because, as we noted, consumer spending accounts for about 70 percent of GDP, real GDP growth falls about 0.84 percent for every 10 percent loss of value in the housing market.

The economists based their research on data on household consumption and finances from the Federal Reserve's Survey of Consumer Finances³ and the Bureau of Labor Statistics' Consumer Expenditure Survey.⁴

The study found that changes in home values have three times the impact on consumer spending than any other change in financial wealth, including stock portfolios.  This is significant because the Case-Shiller home price index reveals that in August 2008, home prices in 20 large U.S. cities dropped a record 16.6 percent from the previous year.To read the full article, you must be a Trends Magazine Subscriber. To learn more, click here