Dow dive could pinch consumer spending

The two-week plunge in stock prices is signaling economic anxiety, but it's also compounding the problem: Lower stock prices are shrinking Americans' wealth, rattling their confidence and making them less inclined to spend.

And employers may become even slower to hire.

The Dow Jones industrial average plummeted Thursday on fears about the U.S. economy and the debt crisis in Europe. The major stock indexes have sunk more than 10 percent from their previous highs.

Economists say sustained drops in stock prices tend to suppress consumer spending as people see their wealth shrink. And consumer spending accounts for about 70 percent of economic activity.

The drop in stock prices could especially slow spending by upper-income Americans. Eighty percent of stocks belong to the richest 10 percent of Americans. And the richest 20 percent of Americans account for about 40 percent of consumer spending, says Michael Niemira, chief economist at the International Council of Shopping Centers.

The drop in stocks “will have repercussions back on the economy,“ says Barry Bosworth, an economist at the Brookings Institution who has studied the link between stock market performance and consumer spending.

All this comes just as fears of another recession are rising. Many consumers, their wages devoured by high gasoline and food prices, are pinching pennies: In June, they reduced spending for the first time in 20 months.

Analysts expect high-end shoppers to keep spending for now, and there is a chance the market may recover sooner than expected. “The question is, how long of a funk do you have to have before those higher-end consumers” scale back spending? says Doug Hart, a partner in the retail practice of BDO USA.

The stock market still has plenty to worry about. Cracks in the European financial system widened yesterday as investors worried that Italy and Spain would default on their debts.

Regulators have put banks there through a series of stress tests designed to show whether they could withstand defaults by their weaker neighbors.

Traders are losing faith in the creditworthiness of debt issued by a growing number of countries and in the banks that hold it. That's causing banks to charge each other more money for overnight borrowing. It's also making short-term credit harder to get, traders say.

There are other ways that Europe's problems could be felt across the Atlantic. European banks that can't get credit might stop lending to U.S. banks and hoard their money. U.S. banks' borrowing costs would rise.

A default by a major European bank could spark a credit crisis like the one caused by Lehman Brothers' collapse in September 2008.

Investors have turned their attention this week to a string of data that show the economy is much weaker than they thought, said economist Tom Porcelli.

“The recovery is going to be long and drawn out and is going to be more painful than many people appreciated,“ he said.