The death of demand
Financial Times, Jun 25, 2001
By GLOBAL INVESTOR - ANDREW HILL
Imagine if demand went away - and never came back. Inflation would die;
companies would be forced to cut costs to sustain profit growth; the central
bank would be pushed into interest rate reductions.
It sounds similar to the first phase of the US economic slowdown. Demand
fell in late 2000, leading to inventory reductions, lay-offs and other
budget cuts by corporate America. Warnings and apologies replaced the
boastful certainties of rapid profit growth. The Federal Reserve rushed to
ease the cost of borrowing. But for certain "demand bears", the downturn at
the end of last year was only the latest chapter in a 30 year saga of
dwindling sales growth in the US.
James Paulsen, chief investment officer of Wells Capital Management, part of
Wells Fargo Bank, points out that from a robust 10 per cent in the 1970s,
annualised sales growth dropped below 8 per cent in the 1980s. It then fell
to 5.5 per cent in the 1990s, its lowest level since the second world war.
He calls this "the death of demand", brought about by dwindling population
growth, tepid expansion of debt since 1990, and the near-disappearance of
government spending as an economic stimulus.
The chances of demand growth reawakening soon are slim. Outside the
developed world, emerging markets will be slow to pick up the slack. Within
the US, consumers are sated with purchases made over the past decade.
Spending on big-ticket durable goods and structures - which include houses
or cars - now stands at record levels as a percentage of total real gross
domestic product. American consumers may not need any more stuff.
Mr Paulsen believes most of the so-called "economic miracles" of the 1990s
and particularly the miracle of corporate profits can be attributed to this
sluggish top-line growth. Until the 1990s, chief executives could rely on
strong expansion in sales. Provided costs were kept under control, profits
would grow at a reasonable rate. But as sales growth stalled chief
executives had to find other ways to satisfy investors' desire for
increasing earnings: they opted to cut costs, improve efficiency through
technology, and achieve economies of scale by taking over the competition.
"The profit miracle of the 90s was not so much a miracle as a survival
tactic by CEOs, trying to find profit when there were no more sales," claims
Mr Paulsen. Clearly there were exceptions. Eighteen months ago, many US
companies' principal problem was meeting demand, rather than finding ways to
compensate for the lack of it.
Rapid revenue growth was the preferred yardstick for analysts forecasting a
rosy future for their favourite dotcom. But, looked at from the dark side of
the internet and telecoms bubble, that spike could be interpreted as an
aberration. A number of US companies have adopted more realistic profit and
sales targets, admitting their previous goals were based on the unrepeatable
operating performance of the late 1990s.
The markets still yearn for a strong economic recovery, however. The nearest
parallel comes from the early 1990s, when the Fed repeatedly cut interest
rates - prompting a series of upward spikes in bond yields and
manufacturers' confidence as investors and corporations tried to call the
rebound. It did not really happen until 1994, four years after the Fed began
to loosen monetary policy.
The US is better prepared this time: the banking system is more robust,
there is plenty of room for the central bank to ease rates further, the
surplus allows more flexibility for fiscal stimulus and, as a last resort,
there is room for devaluation of the dollar. But policymakers could put
those tools to one side, because they are afraid of stoking short-term
inflation. It is unlikely to happen this week: most investors expect the Fed
to cut rates again, by 25 or 50 basis points, but an inbred fear of
inflation could stay the central bank's hand once this sixth cut is in
place. The demand bears believe that would be a serious error.
Full article at:
http://globalarchive.ft.com/globalarchive/articles.html?print=true&id=010625
000852
Michael Keaney
Mercuria Business School
Martinlaaksontie 36
01620 Vantaa
Finland
[EMAIL PROTECTED]
