The economy
Hard luck, hard landing?
Feb 22nd 2001 | NEW YORK AND WASHINGTON, DC
(www.economist.com)
America has been promised a soft landing. Consider an alternative
"DO YOU think we are going to have a recession?" The questioner is a
stranger, clad in an elegant fur coat, in a lift on Fifth Avenue in
Manhattan. It is the question all Americans are asking. When the question
was put in Congress last week to Alan Greenspan, the chairman of the
Federal Reserve, he replied "No". Unfortunately, he said the same in
September 1990, when it is now clear that a recession had already started.
According to the latest survey by Blue Chip Economic Indicators, 95% of
economists agree with Mr Greenspan: America is not sliding into recession.
But this is less reassuring than it sounds. Economists rarely succeed in
predicting recessions. Economic models are not much help for spotting
turning-points in the cycle. And many economists are reluctant to stick
their necks out.
A disturbing number of leading economists in America have privately
admitted to The Economist that they are more worried about a recession
(defined as at least two quarters of falling GDP) than their official
forecast might suggest. Even Stephen Roach, a notorious bear at Morgan
Stanley, is predicting only two quarters of shrinking output, and average
growth of 0.9% for 2001 as a whole. That would make it the mildest
recession in history. But, as Mr Roach admits, it is hard to forecast
recession, let alone deep recession, when your firm sells equities.
Certainly, the trend is gloomy. The average prediction for growth in 2001
in The Economist's poll of forecasters has fallen from 3.5% in October to
1.8% early this month. Actual GDP growth slowed from 5% in early 2000 to
1.4% in the fourth quarter. Many economists expect growth of barely 1% in
the first half of this year. Even without a recession, that would feel like
a bumpy landing.
So far, the main driver of the downturn has been the business sector. As
profits have been squeezed and weaker sales have caused inventories to pile
up, firms have started to trim their investment and production. Mr
Greenspan is keen to portray the current slowdown as mild and short-lived.
Firms have already started to slim their excess stocks, he argues, so the
usual inventory correction should take place more rapidly than usual,
allowing the economy to bounce back more swiftly.
The behaviour of consumer and corporate spending will determine whether
this happens without a recession. John Makin, an economist at the American
Enterprise Institute, believes there is a serious overhang of capital
investment. Even without a recession, capacity utilisation in manufacturing
has fallen to its lowest level since 1992. With excess capacity and falling
profits, firms are likely to cut their investment plans this year.
The most useful economic indicator to watch is consumer confidence. Mr
Greenspan has likened the sudden break in confidence before past recessions
to "water backing up against a dam that is finally breached." It is
difficult for monetary policy to deal with such a sharp break in
confidence. The University of Michigan's consumer-confidence index remains
above its level in previous recessions. But it has just seen its biggest
three-month fall since the start of the last recession (see chart). And, as
Bill Dudley, an economist at Goldman Sachs, argues, the rate of change in
confidence may have a bigger impact on growth in spending than the absolute
level.
Last year, households' saving turned negative for the first time since the
1930s, as people spent their increased stockmarket wealth. Debts also
climbed to record levels in relation to income. If share prices continue to
weaken from their still over-valued levels (see article), that "wealth
effect" will surely go into reverse. If nervous consumers suddenly decide
to save more and spend less, a serious recession could follow.
What would really cause consumer confidence to crumble is big job lay-offs.
So far unemployment has barely increased. But if firms in the
"just-in-time" economy reduce inventories and capital spending more swiftly
than in the past, as Mr Greenspan has argued, then why might they not also
cut jobs rapidly? A spate of recent corporate lay-offs from the likes of
Dell, DaimlerChrysler and Sara Lee augur poorly.
Liquid refreshment
Most economists and investors still have faith in the ability of the Fed to
prevent a recession through interest-rate cuts. With inflation well under
control, the Fed has plenty of room to cut interest rates. At least, that
was the argument before the poor inflation figures for January were
published. Consumer prices rose by 0.6% in the month, twice as much as
expected, to give a 12-month increase of 3.7%; the 12-month rate of
producer-price inflation jumped to 4.8%, its highest for ten years. This
may be just a blip, caused by higher energy prices, but the Fed's room for
aggressive easing may be shrinking.
And even if rates are cut by another half point at the Fed's next policy
meeting on March 20th, there is no guarantee of how quickly this will work.
Monetary policy always operates with long lags, but with record levels of
debt and excess capacity, lower interest rates may be even less effective
than usual in spurring new spending. Easier monetary policy can certainly
shorten recession, but, given America's financial and economic imbalances,
it may be too late to prevent one altogether.
All this leaves one final, predictable reason for optimism. Mr Dudley
points out that investors and consumers (presumably like the woman in the
fur coat) still believe Mr Greenspan can avert recession; that helps to
underpin confidence. Undeniable. Yet, if a recession were to occur, the
shock to confidence could be severe-like discovering that the emperor had
no clothes after all.
Louis Proyect
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