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U.S. Consumer Spending May Slump in a `Cold, Dark' Winter
Will Edwards & Steve Matthews
October 17, 2005

Oct. 17 (Bloomberg) -- U.S. consumers, and the businesses that depend on them, are bracing for what Lehman Brothers Inc. economists call a "cold, dark and expensive" winter.

A growing number of Wall Street forecasters, including those at Goldman, Sachs & Co. and Merrill Lynch & Co., are pulling back on estimates for consumer spending. They cite a convergence of rising energy prices, falling real wages and new rules requiring bigger credit-card payments that threaten to increase delinquencies at a time when a record number of borrowers are already behind on their bills.

"We are hitting the consumer with headwinds that we have not witnessed on record," says Andrew Pyle, senior economist with Scotia Capital in Toronto.

Goldman, Sachs predicts a 1.5 percent annual rate of consumer spending over the next two quarters, half the pace of the previous two years; Merrill Lynch & Co. set its fourth- quarter estimate closer to 1 percent. "It's very likely consumer spending will slow down significantly in coming months," says Ethan Harris, Lehman's chief U.S. economist.

A slowdown threatens not only the U.S. economy -- consumer spending accounts for two-thirds of gross domestic product --but the world's as well: The U.S. is the destination for 18 percent of the world's goods.

Energy prices are the catalyst, though not the only reason, for the anticipated slowdown. The price of crude oil, gasoline and natural gas all reached records after Hurricane Katrina slammed into the Gulf Coast, an energy hub; Lehman estimates consumers will pay $25 billion more this season to heat homes. In an Oct. 14 report entitled "Cold, Dark and Expensive," the firm said higher energy prices may cut U.S. gross domestic product growth by half a percentage point in the next two quarters.

The True Test

The true test for the consumer may come in few months, when heating bills arrive. Some economists say home-equity loans, which are still bolstering Americans' ability to spend, will help cushion the blow; they also take heart from the latest reports on post-hurricane spending. The Commerce Department said Oct. 14 that retail sales rose 0.2 percent in September and by 1.1 percent, the most since April, when auto sales were excluded.

"Despite high energy prices, consumer spending will hold up relatively well," says Jason Schenker, economist at Charlotte, North Carolina-based Wachovia Corp., which forecasts consumer spending increases of 2 percent in the first half of next year, rising to 2.7 percent by the fourth quarter of 2006. "Consumer behavior is not changing a lot."

Feeling the Pain

Consumers are certainly beginning to feel some pain: consumer prices rose last month by 1.2 percent, the most in 25 years, as energy costs posted the biggest jump on record, the Labor Department said Oct. 14.

Merchants including Richmond, Minnesota-based Target Corp., the nation's second-largest discount retailer, and sporting- goods retailer Cabela's Inc. are blaming rising energy prices for hurting sales. On the same day as the inflation report, Sidney, Nebraska-based Cabela's said sales at its stores that have been open at least 15 months may drop as much as 9 percent.

The two consumer categories among 10 subgroups in the Standard & Poor's 500 Stock index have each posted losses in the past six months even as the overall index rose 3.9 percent.

Falling Wages

The surge in energy prices is contributing to a decline in Americans' wages once inflation is taken into account. The Labor Department said Oct. 14 that so-called real wages fell 1.2 percent last month, the biggest drop since January 1996, and that the 12-month decline was the biggest since March 1991.

"There is no question that many households are suffering declines in real incomes," William Poole, president of the Federal Reserve Bank of St. Louis, said at a speech in Washington later that day.

The decline erodes the purchasing power of American consumers, who Morgan Stanley says have accounted for 71 percent of gross domestic product since 2002, up from an average 67 percent the previous 25 years.

"Consumers have stagnant real wages and they are getting hit with the shocks of higher energy prices," says Stephen Roach, the firm's chief global economist in New York. "This is not a good combination for the overstretched consumer."

Delinquent Consumers

Chad and Jennifer Fielding are among those "overstretched" consumers and illustrate another of the risks that may contribute to slower consumer spending this winter.

With energy prices soaring, an increasing number of Americans are falling behind on credit-card payments; at the same time, new rules taking effect by year-end mean most consumers will be required to pay 4 percent of their outstanding balances each month, up from about 2 percent now. That will boost payments as much as $2,400 a year for borrowers with $10,000 in debt.

The Fieldings filed for bankruptcy protection Oct. 2 after their credit-card debt ballooned to $30,000 over a decade of spending. A new law taking effect today will make it harder for consumers to erase debt through bankruptcy.

"You hit a breaking point, and something had to be done," says Chad, 31, an administrator at Henderson State University in Arkadelphia, Arkansas. Jennifer, 32, a teacher, says the couple paid the $900-a-month minimum on cards and "the balance never went down."

Credit Cards

The share of delinquent credit-card accounts rose to 4.81 percent during April to June from 4.76 percent in the prior three months, the American Bankers Association says. Consumers spent 13.55 percent of their disposable incomes on debt service in the second quarter, an all-time high, the Federal Reserve says.

Carl Steidtmann, chief economist at Deloitte Research in New York says delinquencies may approach 6 percent this quarter as the higher minimum payments take effect. Some companies already may be feeling the pinch. Citigroup Inc., the largest U.S. financial services company, later today may report its first drop in profit in five quarters because of rising credit- card defaults, based on average economist forecasts in a Thomson Financial survey.

Fed policy makers say overextended consumers may be a source of weakness for the economy.

"There will be some pressures on households, and that will be particularly true if we have a cold winter and natural-gas prices go up even further," Poole said in an Oct. 4 press briefing. Bankruptcy filings rose ahead of the new law, which may be giving an incentive for filings, he said.

Rising energy prices will prompt consumers to "pull back on spending," Thomas Hoenig, Poole's counterpart at the Kansas City Fed, said Oct. 5. "Consumer debt has risen," he said, and the increase in "is significant."

To contact the reporters on this story:
Steve Matthews in Atlanta at  smatthews@Bloomberg.net;
Will Edwards in Charlotte at  wiedwards@bloomberg.net.

Last Updated: October 17, 2005 00:15 EDT

If you think high gas prices suck, wait till we have high gas prices and high heating prices. The two should be enough to cause rampant inflation, high interest rates and a very severe recession.

In other words, prepare for the worst and hope for the best.