Finally, Americans are saving. For retailers, that's a disaster

WASHINGTON — After a year of economic crisis and an even longer slump, the nation's retailers are facing a consumer who's more reluctant to buy than ever before in modern times. All signs point to a new era of frugality.

Whether it's because of job losses, uncertainty about employment, banks tightening lending, high debt or eroding income, the U.S. consumer is tightening her belt and doing without.

That's a big problem for the U.S. economy. Consumers in recent years have accounted for about 70 percent of American economic activity, so their reluctance or inability to spend matters. With the jobless rate at 9.7 percent and expected to keep rising for months, consumers are likely to remain hunkered down.

Federal Reserve data released Tuesday showed that consumers cut borrowing in July by an annualized 10.4 percent. The dollar amount of the decline, $21.6 billion, was the largest month-over-month decline on record.

A lack of borrowing translates to a lack of spending.

"Consumers continue to be incredibly cautious," said Scott Krugman, a spokesman for the National Retail Federation, which represents nationally known retailers.

Sales at stores open for more than a year posted a 2.9 percent drop in August. That's not as bad as July's 5.1 percent decrease and was smaller than expected, but it was still a drop. Moreover, any improvement in retail sales reflects only statistical growth from a deep bottom.

Adding to retailers' woes, the government's "cash for clunkers" program helped spur car sales, but maybe at the expense of other spending.

"Consumers that a year ago, or even six months ago, might not have expected to have a car payment now do. Naturally that money was going to have to come from somewhere: It came from their discretionary spending," Krugman said, noting that "cash for clunkers" purchases ate into other summer retail sales. "That's not the sole reason. Obviously it was going to be a challenging back-to-school season" anyway.

Having tried steep discounting, retailers are still searching for a formula to get consumers spending again. They fear that people will spend only for bargains.

"The biggest change is that consumers are now firmly in the driver's seat. For over a decade they spent relatively freely. Not anymore," said Ted Hurlbut, a Boston-based retail consultant. "They have become far more cautious, and their emphasis on intrinsic value is now far more than a rational response to economic realities. It's become a cultural virtue."

Thrift is becoming a habit as well as a virtue.

"I do think there is going to be an attempt by the American consumer to be somewhat more judicious in terms of his spending, and to try and gradually get his balance sheet in order," said Martin Regalia, the chief economist for the U.S. Chamber of Commerce.

A survey titled "The New Normal," published in March by Alix Partners, a consulting firm, underscores this point. People were asked about their biggest economic concerns. Eliminating personal debt ranked first, followed by fear of job loss and recovering lost retirement savings. When they were asked about economic concerns five years from now, the same three topics dominated.

The survey also found that Americans expect to save on average 14 percent more once the recession is over than they did before it; if that's true, that means the "new normal" would involve consumer spending at 86 percent of pre-recession levels. That would cut U.S. spending by more than $1 trillion a year.

Retailers are reacting by reducing the products that consumers can choose from and narrowing their choices of colors and styles.

"They are dramatically cutting inventories. We're going to see stores look like they've never looked before, and part of this is to put a floor (under) prices and create a sense of urgency with products," said Hurlbut, the retail consultant. "We could see fairly long-term changes in spending and habits."

There's evidence of this in SpendingPulse data compiled by MasterCard Advisors, the professional services arm of MasterCard. Its research finds that consumers are ramping down purchases of luxury items.

Luxury spending fell in August by 12.9 percent below the same month last year. SpendingPulse defines luxury goods as the upper 10 percent of prices at department and retail stores, leather goods boutiques, jewelry stores and restaurants.

In the summer of 2008, consumer spending on luxury goods was flat, then nosedived after last September's financial-markets meltdown. In dollar terms, the $1.7 billion spent in August on jewelry is equivalent to sales figures from August 2005, before the peak of the economic boom.

"It's like the industry has kind of gone back in time three or four years," said Michael McNamara, the vice president of research and analysis for SpendingPulse. "It's like two or three years ago didn't happen."

Statistically, retail sales in the coming months are likely to look better, because they'll be in comparison with the disastrous final three months of last year.

Meanwhile, some analysts hold out hope that the new frugality may wane as the economy improves.

"A lot of that was said after 9-11 as well. The consumer is resilient," said Krugman, the spokesman for the National Retail Federation. "Once the economy starts improving, you're going to see a ripple effect. I think the consumer believes the economy is improving. They just need a little more proof and it needs to hit closer to home before they loosen the purse strings."