Turmoil May Scare Consumers Spending Pull-Back Would Slow Economy

The stock market’s roller-coaster ride could scare some of the vitality out of the U.S. economy. Without the reassurance of ever-rising share prices, American consumers may shop less and businesses may trim expansion plans, analysts say.

Even if the market continues roaring back as it did Tuesday, the vivid memory of Monday’s 554-point plunge could leave stock owners less confident of gains and therefore less likely to spend.

Consumer confidence already was sliding before this week’s tumult, according to a survey of 5,000 U.S. households by a private business group in New York.

The Conference Board said its confidence index, an important measure of consumers’ propensity to spend, dropped seven points in October to 123.3 from September’s 130.2.

One economist - Bruce Steinberg of Merrill Lynch - already has shaved half a percentage point off his growth estimate for next year. That may not sound like much, but it amounts to about a $40 billion cut in production.

It works through something called the “wealth effect.” The biggest factor in consumer spending is income, primarily wages. But wealth - in the form of home prices and the stock market - plays a role, too. A rule of thumb is that Americans spend about $3 more for every $100 increase in wealth or $3 less for every $100 decrease.

But it’s a rule with a lot of elasticity.

Gyrating stock prices have much the same psychological impact on business executives as consumers. Plus, there’s a practical impact on companies’ ability to raise the money needed to build more factories and buy new equipment.

“You have to issue more stock to get a given amount of money. So that’s a detriment to capital spending,” said economist Bob Dederick of Northern Trust Co. in Chicago.

And companies dependent on sales to Asia face the prospect of curtailed profits. With 29 percent of U.S. exports now going to the Pacific Rim, that, too, will mute the vibrancy of the American economy.

On a brighter note, the flow of money out of the stock market and into the bond market has held long-term interest rates near 20-month lows, offsetting some of the dampening effect of stock turmoil.

If long-term rates stay low, that would save money for consumers still buying homes and big ticket items such as cars. And it gives businesses an alternative to issuing stocks - selling bonds.

Short-term interest rates probably also will stay put. Many analysts had thought the Federal Reserve was gearing up to fight inflation with a dose of higher rates before the end of the year.

But economist Mark Zandi of Regional Financial Associates in West Chester, Pa., said the stock drop in the past two and one-half months has about the economic dampening power of a half-point increase in short-term interest rates.

“The decline in stock prices has done the Fed’s heavy lifting. The Fed can remain on the sidelines and wait and see what happens,” he said.

Even if policy-makers had been inclined to fret about inflation, a Labor Department report Tuesday showed businesses are holding the line on wages and benefits despite nearly the lowest unemployment rate in 24 years.