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The economy is booming, but there are big risks

Improving wages and tax cuts are yielding more spending, but consumers' lack of savings makes for a shaky foundation.
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The economy is booming: Wages are finally growing, consumers are spending and are feeling more confident in their jobs as unemployment has fallen below 4%.

But that economy is on a shaky foundation that could falter quickly if something induces a panic, according to Arjun Chakravarti, assistant professor of management and marketing in the Stuart School of Business at the Illinois Institute of Technology.

“Things are looking pretty good,” Chakravarti said at the Restaurant Directions conference in Nashville on Tuesday. “But it’s also being held up in the air.”

One of the problems is the savings rate. Consumers are spending more in 2018, in part because they’re saving less.

That could mean that consumers are feeling so confident in their jobs that they don’t feel the need to save as much. But it also means that wages aren’t keeping up with spending.

In addition, consumers aren’t moving in search of higher wages like they once did, rather focusing on keeping their costs low because wages aren’t growing.

That combination means that the economy, though on one of the longest growth streaks in history, is not as strong as it has been during past periods of growth.

“It’s not this amazing, robust economy,” Chakravarti said. “There are a lot of artificial factors holding it up behind the scenes. It could lead to a panic pretty quickly.”

One of the factors that could be driving up restaurant sales at the moment is wage growth among younger consumers, who are more likely to spend their wages at restaurants.

Wages among younger consumers are up 5% since 2016, but that’s also up from a base of flat wages, and remain relatively low.  

The higher wages could be driving up consumer confidence, which is currently at levels not seen since the late 1990s.

But Chakravarti cautioned that the University of Michigan Consumer Confidence Index is increasingly influenced by political events. He said that Democratic-leaning states had a higher consumer confidence before the election, while confidence was low in Republican-leaning states.

That has since reversed.

“The consumer confidence rating which we used to use as a forward indicator is a little bit all over the place,” he said. “I wouldn’t use it as much of a leading indicator for anything.”

For the moment, tax cuts approved late last year have generated confidence among investors, especially as wealthier consumers save more money as they’ve paid less in taxes. Much of the savings at the moment, Chakravarti suggested, could be coming from the wealthiest households.

Another potential challenge for the economy, and for restaurants, is prices. For the moment, businesses have been able to hold the line on prices.

But rising transportation costs could force many businesses to raise prices in the coming months, and that could dampen the higher consumer spending that has helped drive the economy forward.

Gas prices have started rising in recent months, and that could ultimately hurt industry sales. As gas prices decline, 20% of those savings tend to be spent at restaurants. As gas prices rise, that could take sales away from restaurants.

Chakravarti, however, doesn’t expect gas prices to rise above the $4 level, which Technomic Managing Principal Joe Pawlak believes to be the “magic number” that leads consumers to cut spending elsewhere.

Another challenge Chakravarti sees is housing. At the moment, a lack of supply and high demand are driving up housing prices. “People are taking on more house debt than usual,” he said.

Chakravarti said that an overheating economy could ultimately lead to a recession. He also suggested that some sort of shock, perhaps through an escalating trade war, could also hurt the economy.

But he said the most likely scenario is that the Federal Reserve creates a recession by raising interest rates too quickly in a bid to keep inflation in check.

“It’s a pretty hard situation to be in,” Chakravarti said. “That’s what makes the market we’re in right now a tenuous one.”

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