Slumping stock market may crack consumer

By Emily Kaiser - Analysis

WASHINGTON (Reuters) - The stock market may be the deciding factor in whether the U.S. economy tips into a consumer-driven recession this year.

Much of the hand-wringing about the big threat to household spending has focused on the slumping housing market, but history suggests consumers can withstand one serious blow to their wealth. A double-barreled assault can be disastrous, so if stocks keep sliding, spending may finally buckle.

Peter Ireland, an economics professor at Boston College and former researcher for the Federal Reserve Bank of Richmond, said that until recently, homeowners stung by falling property values could still take solace in the stock market, which managed to finish a tumultuous 2007 with gains, albeit slim.

With U.S. stock markets off to their worst start in history this year and a growing number of economists predicting a recession, households may begin worrying about their nest eggs and do something they haven't done much of for years -- spend less than they earn.

"American consumers have been playing a game where they save, in a sense, without savings, relying on capital gains," Ireland said. "The big question there is how will long will it last? If we get to the point where American consumers start to feel like the only way of saving is to actually do it the old fashioned way ... that could make 2008 a tougher year than we might have hoped for."

Investors and economists are keeping a close eye on consumer spending because it accounts for more than two-thirds of U.S. economic activity. If household spending dips, it would likely sink the economy into recession.

Ireland said that if the Dow Jones industrial average holds above the 12,000 mark, consumers will likely hang on, anticipating a bumpy but relatively brief ride. Below that level, he envisions household spending falling as investors gasp over double-digit declines in their stock portfolios.

The Dow was up 0.71 percent at 12,675 in mid-morning trade on Wednesday.