The U.S. economy is in a confusing place. The fundamentals look strong: Jobs are plentiful, inflation is tame, wages are rising and the economy continues to grow a tad above 2 percent, which most experts think is the Goldilocks pace.
They point out that the bond market is showing a big red flag (the inverted yield curve) and job openings are starting to fall, factors that normally signal downturns are coming. And they note that by just about every measure, the economy is slowing from a year ago, making it more vulnerable to a big shock like President Trump’s escalating trade war.
Where things go from here largely hinges on a single factor: the almighty consumer.
Broadly speaking, economic growth in the United States is driven by three factors — spending by consumers, the government and businesses. At the moment, businesses have pulled back because of the trade war, and government spending is not expected to change much, especially with a two-year budget deal in place. That leaves the consumer as the most significant variable that can change the country’s fortunes.
In other words, the spending levels by ordinary Americans will decide whether a recession will come sooner rather than later. And therein lies the strength and weakness of the economy: It depends on people. Their spending makes up about 70 percent of economic activity, and they rely on their gut feeling about the economy when they decide whether to make big purchases such as cars, refrigerators or fancy birthday dinners.
The latest data on consumer confidence that came out this week caused a sigh of relief on Wall Street and in the White House. Americans think this is the best economy since 2000, the Conference Board reported, although expectations about the future fell a tad and more people think stock prices will decline in the next year.
“Consumer confidence for the time being remains strong. It’s being supported by job growth and income growth and a lot of the fundamentals,” said Lynn Franco, director of economic indicators at the Conference Board. But Franco added a warning, “If the trade war begins to translate into higher prices, that could have implications for consumer spending.”
Trump’s decision to raise tariffs on imports hasn’t discouraged people from visiting stores (or shopping online) yet, but his next round of tariffs is set to hit popular items such as shoes, phones and laptops, and business leaders are already on edge. U.S. companies have cut back spending sharply because they don’t like investing in new factories or initiatives when the business environment is unstable.
Right now, many executives can’t tell whether the trade war between the United States and China will get better or worse. On Friday, Trump called Chinese President Xi Jinping an “enemy” and announced higher tariffs, but by Sunday he was praising China and expressing optimism about the trade talks.
The concern is that after businesses stop spending, they typically pare down hiring — or even start layoffs. That would be a devastating blow to those who lose their jobs, and it has wider psychological effects. Even for those who are still employed, negative headlines about market drops, mass layoffs and gloomy expectations can spook Americans into tightening their belts.
Without optimistic consumers, this economy has a lot less chance of staving off a recession.
“The consumer has held up so far, but the consumer is always the last to go when there is a downturn,” said Michelle Meyer, chief U.S. economist at Bank of America Merrill Lynch.
Consider what happened when the markets plummeted in December, for instance. There isn’t a perfect correlation between market drops and consumer sentiment, but consumer confidence sank in January after the stock market was down nearly 20 percent around Christmas. That happened even though the labor market and economic growth were still strong.
By comparison, Trump’s latest announcements of more tariffs on Chinese imports sent stocks down in the past month, but only about 5 percent, a much milder dip that has yet to significantly change consumer confidence.
“For the Main Street consumer, the economy right now is better it has been since before the financial crisis. They have jobs and that single factor is what is sustaining the consumer,” said Peter Atwater, founder of Financial Insyghts. “They look at all of this other stuff — the trade war and discussions of a recession — and I think they are saying, ‘Until it impacts me, it’s noise.’ ”
Trump and his aides have lavished praise on the economy recently, an effort that is partly about touting Trump ahead of the election but also about trying to prevent a sense of doom that can sink the consumer mind-set. The problem for some economists is that it can make the administration appear as if it is ignorant of the gathering storm.
“We are in a system in which things are getting worse day by day,” said Stanley Fischer, former vice chair of the Fed, who blamed Trump for the problems. “It’s not a service to anybody, at least privately, not to focus on what the key problems are. And that would be the behavior of the United States.”
For now, consumers continue to buy back-to-school gear, yoga classes and vacations. They have been buoyed by gains of about 6 million jobs in the past three years, wages that are rising well above the cost of living and tax cuts for most households.
Economists say what would really tip consumer confidence is if businesses pull back on hiring. And there are early signs that might be starting to happen.
While the economy continues to add jobs at a healthy rate, the pace has slowed from 223,000 job gains a month last year to 165,000 this year. Job openings have also declined in the past several months as some executives say they are in wait-and-see mode because of the U.S.-China trade war.
“There are major political shocks occurring across the world, and those political shocks are turning into economic shocks,” said Philip Lowe, head of the Australian central bank. “Businesses that are not investing are hiring people, but it wouldn’t take too much for businesses to decide not to invest or to hire people.”
Industries most directly affected so far by the trade war are already in trouble. Manufacturing, while a small part of the U.S. economy, is in a recession, defined as two quarters of shrinking output.
In the agricultural sector, farm bankruptcies have jumped 13 percent nationwide and 50 percent in the Northwest over the past year, according to the American Farm Bureau. States that are more dependent on these struggling industries also are showing early indications of pain. While unemployment claims are down nationwide, they have jumped noticeably in Iowa and surrounding farm states.
The optimistic case is that consumers will continue to spend, ignoring the mayhem between China and the United States and the recent gyrations of the markets. The pessimistic case is that these latest blows between the United States and China will add up to a psychological blow that will persuade even healthy businesses to stop hiring and consumers to limit their spending. So far, however, that hasn’t happened.
As JPMorgan economists Jesse Edgerton and Daniel Silver put it in a note this week: “We continue to see significant risk of a recession beginning within a year if sentiment and labor markets deteriorate further but still believe it is too soon to conclude that a recession is the most likely outcome.”