I read this fellow as presenting a very mechanistic version of a Marxian over-investment cycle, in which over-accumulation leads to crisis, which in turn leads to the purgation of imbalances and then recovery of accumulation. (This shouldn't surprise us, since the "Austrians" and Schumpeter owe a lot to Marx, as S. acknowledged.) He only looks at the excess capacity dimension of the cycle, ignoring the debt overload and the problem of pessimistic expectations. Unlike the Roach article that preceded it, he ignores international dimensions. Further, he misses the downside of the purgation cycle, i.e., that the purgation may be _too_ painful, leading to what I've called the "underconsumption trap" (wages being pushed down to save profits, but hurting consumption demand and profits) and what Fisher called "debt deflation." It also ignores any social disorder encouraged by recession, which can hurt capitalist expectations.
----------------------- United States: Purging Excess -- The Capacity Overhang Richard Berner (New York) That there is a capacity overhang, especially in high-tech industries and investment, has long been a cornerstone of our U.S. recession call (for example, see "The IT Crash: How Big? How Long?" Global Economic Forum, February 26, 2001). We've highlighted the grim implications: First, overinvestment crushed returns on invested capital, massively squeezing profit margins. Second, the glut killed pricing power, worsening that squeeze. And in response, Corporate America would have to slash capital spending to purge the excess, triggering recession. The eternal question: How long would it take to end the glut -- months or years? Believe it not, now there's light at the end of the tunnel: The capital spending bust is purging the excess, and with the exception of communications equipment, the overhang could be gone in a year. That will help set the stage for recovery, one that likely will surprise by its vigor. A year! That timing may come as a shock to those who agree with my business cycle logic, which harks back to the Austrian theorists like Schumpeter and Haberler, but who believe that the excess is so massive that it will take years to shed. Indeed, my colleague Barton Biggs eloquently summarizes the Austrian point of view to question the common view that recovery is around the corner: "For the economy to truly recover, ...bad investments must be liquidated. This is the 'creative destruction' that leads to eventual recovery." (see "What am I Missing?" Investment Perspectives, November 6, 2001).Barton is right. Recovery is not around the corner. But recession is telescoping the restructuring process, and it is not too soon to anticipate the turning point in the economy that will result (see "Restructuring Corporate America," Global Economic Forum, October 29, 2001). There's no mistaking the excess in capital spending. Measured by the growth of capacity relative to output, the glut is the biggest on record. Different metrics tell the same story. Over the past seven years, the growth in business capacity (measured by the real stock of equipment and structures) averaged 7.1% -- double the pace of GDP. That capital deepening, so essential for productivity improvement, simply went over the top. The more dynamic equipment and software component (including capacity resulting from both high and low-tech outlays) soared at nearly a 24% annual rate. And while the Federal Reserve's measure of overall industry capacity rose at a hearty and unsustainable 5% annual pace, that in high-tech industry grew at a staggering 50% annual clip. This glut, coupled with the economic slump, brought operating rates down by nearly 10% over the past year. Correcting such a record glut surely must be a Herculean task, but the process is well under way. Although it is only a year old, the capital spending bust in a still-growing economy has so far nearly equaled cyclical norms for recession. Business capital spending plunged by 8.3% over the past year, while in the typical postwar recession, the peak to trough decline averaged about 10%. (Certainly there were some, as in the 1950s, that were far deeper.) Getting this head start is good news for restructuring, and judging by the recent plunge in nondefense capital goods orders excluding aircraft -- down 26.5% year-on-year -- the downdraft is accelerating. But will even this freefall be enough to correct the overhang relatively quickly? Three very different sets of calculations all come to the same conclusion: They suggest that the glut -- or at least the bulk of it -- could be gone in another year. One way of making that judgement is to ask what would it take to stop the growth in capacity. Note that capacity is still growing despite the plunge in investment outlays, because new spending net of depreciation is still positive. We calculate that another 15-20% decline in real business outlays would halt that net increment to capacity, allowing operating rates first to stabilize and then rise even with meager growth. That's not wildly different from our current projected decline of 13%. Statistical relationships designed to predict investment outlays provide a second set of calculations for measuring the glut and how long it will take to eliminate it. These rely on a notion of the long-term optimal capital-output ratio, given the cost of capital. Such a notion is especially important for gauging excess, because I believe that whatever the other incentives to invest heavily in IT and other outlays, the era of low-cost capital encouraged excess. Sure enough, such relationships consistently underpredicted IT spending over the past five years, even allowing for falling IT prices and a favorable financing climate, hinting at excess. Cumulating the errors from such relationships yields a crude measure of the overhang, with the excess for computers and software at its peak amounting to about $30 billion in real terms, or about 3% of the outstanding stock. Using this crude metric suggests that the bust has already trimmed the overhang significantly, and that it will be essentially gone by early 2002. While that conclusion is too optimistic, in my view, this calculation gives a starting point. A third and final computation comes from the Federal Reserve's own capacity growth projections that are used as inputs to their measures of industry capacity utilization. Fed staff estimate that the growth of industrial capacity has already slowed to about 1.5% annualized in the current quarter, compared with 4.6% a year ago. This slump in capacity growth is the most dramatic in the history of these data, which began in 1967. Extending that decelerating trend would arrest the growth in capacity by mid-2002, corroborating the timing of the other two calculations. That three sets of calculations add up to similar results is powerful support for the notion that purging the capacity glut won't take years, but months. The bad news, of course, is that further staggering declines in capital spending are likely -- and needed --in the immediate future. And working off the glut in some key industries, such as communications services and equipment, will take much longer; there, the overhang is bigger than macro data suggest. Communications analyst Simon Flannery expects that U.S. telecom capex will plunge by 20% next year, with possibly more to come. But such purging likely will correct at least the bulk of the much-feared overhang of capital. For an economy handicapped by falling profit margins and sinking returns on invested capital, that is good news. It will lay the groundwork for an end to the bust in capital spending. And it will set the stage for recovery in operating rates and in profit margins.
