Cult of the Consumer Keeps Thriving

All the chatter about the state of the U.S. economy boils down to one essential thing: the resilience of the American consumer, the sole prop keeping the largest economy in the world out of a recession.

On Tuesday, Wall Street will get the retail sales report for July. Most experts think consumption levels aren't imperiled yet because of the tax rebate checks, some of which are already being spent, and the latest economic reports. But even the most optimistic observer concedes that consumer confidence can be a fragile thing, especially if corporations hand out more pink slips.

"I'm not convinced the consumer is going to lead us out of the depth of a slowdown," said Mitchell Held, an economist at Salomon Smith Barney. "But there are some encouraging things out there that, in some ways, the market is overlooking." Here's a short list of the factors experts see working in the economy's favor.

Tax Rebates

There are no guarantees that consumers will spend the majority of their rebate checks in stores. Nevertheless, the latest polls show that people are willing to spend at least a portion of their money. According to last week's chain-store sales reports, retailers like Wal-Mart (WMT Quote) posted higher sales in the second half of July because of the rebate checks. The nation's largest retailer, which will report its second-quarter earnings Tuesday, said consumers are spending about 25% of the rebate checks cashed in its stores.

"People traditionally save two-thirds and spend a third. Even if we get that historical situation, it's still a lot of money coming into the economic system," said Held, who thinks the positive effects from the tax rebates will trump the rather bleak economic outlook in the Federal Reserve's Beige Book report, released last Wednesday. Gerald Cohen, a senior economist at Merrill Lynch, was also hopeful, pointing out that "$38 billion over a course of a quarter's a pretty significant amount. We think it's going to keep the economy going."

Unemployment's Under Control

According to a recent report by the National Bureau of Economic Research, the latest data suggest that manufacturing was the weakest link in the U.S. economy, but employment and real personal income haven't fallen significantly.

July's unemployment reading, which held steady at 4.5%, is still far below jobless readings in the past. "Unemployment is at an exceptionally low level," said Cohen. "It has risen from last year's 30-year low, but it remains at levels that 10 years ago people thought were unrealistic. If you asked an economist 10 years ago at what level would they be worried that unemployment was too low, they would have said 5%."

Some believe the unemployment rate could inch above 5% by the end of this year or early next year, but others think the impact on the consumer will be slight. Bill Cheney, chief economist at John Hancock Financial Services, said the market has been "unduly pessimistic" about the job losses and bad news coming from the manufacturing sector.

"The other eighty-something percent of the economy is not in a recession," Cheney said. "People have their jobs and they're spending money. In many ways it's a good time for people to be out buying things."

What Inflation?

Despite the Fed's aggressive easing this year, price levels are still under control, and have even fallen in some cases. Friday's producer price index dropped 0.9% in July, the biggest decline since August 1993, as gasoline and heating prices tumbled. The core PPI index, which excludes food and energy, rose 0.2% after rising 0.1% in June. The PPI gauges inflationary pressures before they affect consumers. The consumer price index will be released Thursday.

Lower prices are an incentive to spend, and they work in a similar way to getting a tax break. "Maybe the [fall in energy prices] is going to be more of a prop to consumer spending than we give it credit for," said Held, who's encouraged that inflation is decelerating "at a very healthy clip."

According to the latest PPI report, gasoline prices fell 17.7%, the biggest drop in 15 years, while heating-oil costs fell 9.1%, the largest decline in three months. However, prices for residential electricity rose 2% -- the biggest gain in 10 years. Wholesale food prices also fell in June, by 0.6%.

There's Still Greenspan

"This is not the Japanese economy," said Cheney. "When interest rates are low, people [in the U.S.] borrow and spend." American consumers get a boost from the Fed's aggressive monetary policy. Many experts are keeping the faith that the six interest rate cuts this year will soon work their magic. And they expect the Fed, which meets again on Aug. 21, to keep easing until the economy is proven to be out of the woods.

"The fact of the matter is, the transmission mechanism for monetary policy through lower short-term rates and a steeper yield curve is working," said Held. "It's just a matter of having that work through and a matter of patience more than anything else."