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If anything, US set for a slowdown, not ... Why the brouhaha about hedge funds is su... How a man called Strive beat off the cor... |
If anything, US set for a slowdown, not recession
A downturn in the US is looking more likely by the day. But full-blown recession is a different matter.
Few economists are predicting a recession next year. J P Morgan is the only big Wall Street investment bank to forecast that the economy will shrink for two consecutive quarters (the technical definition of a recession). Yet most boffins reckon the chances of one have risen. Are they right, or is the US merely lurching from irrational exuberance to an equally exaggerated pessimism?  So far, it is hard to tell. The US economic fundamentals are still strong. Unemployment remains near historic lows, the budget is in surplus, and inflation is low. Economic growth has remained relatively robust. But it is the outlook that, in Alan Greenspan's words, has "weakened measurably" in recent weeks, driven by an ever-gloomier global economy and by turmoil in US financial markets. The risk of recession depends mostly on how far this chaos on Wall Street translates into lower investment on Main Street and less spending at the mall. Until now, the main channel through which global turmoil has dragged down US growth has been international trade. Exports have plummeted as customer countries, especially in Asia, have plunged into deep recessions, and the US current-account deficit has risen dramatically. Some economists reckon the worst of the trade effect is now over; others suggest there is more to come, pointing to the prospect of recession in Latin America, which accounts for one-third of the US's export market. Either way, the trade drag next year will still be substantial. Depending on how fast the economy grows, the deficit could reach between $270-billion and $300-billion in 1999, up from $155-billion in 1997.  That drag alone would not be enough to cause a recession; but a collapse in capital spending might be. For the past five years, business investment has shot up at an average of 10% a year in real terms, as fat profits and easy finance have encouraged firms furiously to retool and expand. Although corporate profits have weakened sharply this year, corporate spending has not. As a result, borrowing has shot up. And as business investment has continued to outstrip the growth of demand, capacity utilisation is falling. Clearly, companies will not continue to invest heavily forever if both profits and the rate of capacity use are falling. JP Morgan expects business investment to fall at an annual rate of between 5% and 9% in the first three quarters of 1999. Other forecasters are less pessimistic, suggesting capital spending will merely remain flat. So far, there is little statistical evidence of a collapse in capital spending, though rumours of such a collapse abound. In a recent survey, 36% of the members of the Business Council, an association of some top US executives, said they planned to cut their investment. If a credit crunch prevents them borrowing, investment will have to be cut whatever their plans. Businesses will certainly invest less if they sense demand is falling. That is why the most important determinant of the US economic outlook is the American consumer himself. Consumption accounts for almost 70% of gross domestic product in the US, and, until recently, it was roaring along. Consumer spending grew at over 6% a year in the first six months of 1998, the strongest two-quarter growth of this expansion. Though September was perhaps weaker than many economists expected, there was no sharp slowdown during the summer. Excluding car sales (which were distorted by the GM strike), retail spending grew by an annualised 4% in the third quarter. How soon, and how sharply, might things change? If lower capital spending and pressure on the export sector reduce overall employment growth, that will quickly dampen income and hence spending. There are signs of weakness about, employment with temporary help agencies is flat, and evidence is mounting of higher layoffs, but overall, the labour market remains extremely tight. It is less clear how consumers will react to growing financial turmoil. Buoyed by gains on the stock market, they had been emptying their wallets far faster than their incomes were rising, with the result that the US personal savings rate fell in the second quarter of 1998 to its lowest level since 1945. As shares tumble and gloom deepens, that may all change. The stock market is now down more than 15% from its peak in early July. If share prices tumble further, or if consumers become concerned about the prospect of recession ahead, a sharp reduction in spending (and higher saving) is easily possible. The psychology of richer Americans, who own most of the shares, is particularly important: families earning above $50 000 a year account for nearly half of all consumer spending. This means that the more consumers fear a recession, the more a recession is likely. Yet although consumer confidence has fallen recently, there is no sign yet that ordinary Americans are gripped with the panic that has beset Wall Street. This means a slowdown, but not a recession, remains the most likely prospect for 1999. Even Wall Street's gloomier forecasters predict only a minor downturn. During the recession of the early 1980s the US unemployment rate shot up, to near 10%. In contrast, JP Morgan's recession forecast for 1999 expects unemployment to reach only 5.7%. Yet the economists are worried a slowdown, if it comes, will be different from other post-war recessions, and possibly harder to correct. Traditionally, the US economy has turned down after the Federal Reserve has jacked up interest rates to fight inflation. This time, the slowdown will be led by a credit crunch and weaker confidence in the private sector. Yet there is an obvious tool to fight such a slowdown: monetary policy. By cutting interest rates, as the Federal Reserve began to do last month, central bankers can increase liquidity, boost those areas of the economy that are sensitive to interest-rate shifts, weaken the dollar, so helping exporters, and bolster equity markets. Given this arsenal of monetary and fiscal policy, a serious downturn looks unlikely. Alan Blinder, former vice-chairman of the Federal Reserve, pulls no punches. "For the US economy to go into a significant recession, never mind a depression," he suggests, "important decision-makers would have to take leave of their senses." With luck, even in Washington, that would not happen. - © The Economist Newspaper Ltd, London 1998. Top of page
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