When consumers feel uncertain about their financial future, they cut back on spending.
When this lack of confidence deepens, it can result in a big economic slump or even a deflationary spiral if consumer pessimism persists to an extreme degree.
As Robert Prechter's Conquer the Crash states:
The psychological aspect of deflation and depression cannot be overstated. When the trend of social mood changes from optimism to pessimism, creditors, debtors, investors, producers and consumers all change their primary orientation from expansion to conservation. As creditors become more conservative, they slow their lending. As debtors and potential debtors become more conservative, they borrow less or not at all. As investors become more conservative, they commit less money to debt investments. As producers become more conservative, they reduce expansion plans. As consumers become more conservative, they save more and spend less. These behaviors reduce the "velocity" of money, i.e., the speed with which it circulates to make purchases, thus putting downside pressure on prices. The psychological change reverses the former trend.
Indeed, the "primary orientation" of consumers appears to be leaning more to "conservation" versus "expansion."
Read this excerpt from a Jan. 29 Associated Press article:
U.S. consumers slowed their spending by 0.2% in December, cutting back for a second straight month in a worrisome sign for an economy struggling under the weight of a still out-of-control pandemic.
The decline reported Friday by the Commerce Department followed a seasonally adjusted 0.7% drop in November. It was the latest sign that consumers, whose spending is the primary driver of the U.S. economy, are hunkered down and avoiding traveling, shopping and dining out. Since making a brief bounce-back from the viral pandemic last spring, consumer spending has barely grown. Sales at retailers have declined for three straight months.
Friday's report from the government also showed that personal incomes, which provide the fuel for spending, rose a modest 0.6% after two months of declines. Yet Americans who have been fortunate enough to keep their jobs have been largely stockpiling savings rather than spending. That could bode well for the economy later this year, once consumers feel more willing and are more able to spend.
The latest figures reflect a shaky economy. On Thursday, the government estimated that the economy grew at a 4% annual rate in the final three months of 2020 but shrank last year by the largest amount in 74 years. At the same time, the job market is faltering, with nearly 10 million jobs still lost to the pandemic, which erupted 10 months ago. Hiring has slowed for six straight months, and employers shed jobs in December for the first time since April.