Poof! Capital Spending Up in Smoke
Jun 17 7:35am ET
By Melissa Goldfine
CHICAGO (Reuters) - For most of the U.S. economic expansion, which has now tottered into its 11th year, capital spending worked magic, fueling productivity and fostering growth.
But as the economy softened and businesses pulled back from laying out money to improve their assets, investment staged a disappearing act that could last until the end of the year.
Non-defense capital orders excluding aircraft parts, a component of durable goods orders that economists use to gauge the health of capital spending, fell 4.6 percent in April, the most recent month for which data is available.
Spending on computers and electronics fell 10.3 percent in April versus a slide of 4.6 percent in March.
An early peak at this qtrs earnings?????
Another measure of capital outlays -- the gross private domestic investment equipment and software portion of gross domestic product -- has also posted steep declines.
In the first quarter of 2001, the Commerce Department estimated real growth in the component contracted at an annual rate of 2.6 percent, versus 20.6 percent growth in the first quarter of 2000.
"The bottom line is that this is the weakest part of the economy," said Ethan Harris, co-chief economist at Lehman Brothers. "You're seeing the adjustment occur very fast. One of the new things about the so-called 'new economy' is corporations are much quicker to respond to profitability problems and try to cut costs."
COMPANIES CUT SMALL STUFF
Anecdotal evidence also underscores a drop-off in capital spending, as companies in many sectors have slashed budgets. International Paper Co. is one example, cutting back on the small stuff to create cost savings.
The paper and forest products giant is delaying equipment replacement and upgrades, roof repairs and building expansions, which helped trim its capital spending budget from $1.2 billion to $1 billion in 2001.
"It's the small, incremental-type things," said Jules Weiss, assistant treasurer at International Paper.
"You just kind of tighten the belt across a broad array of different areas. That adds up."
Capital spending on things like new computers and machines raises productivity by making companies more efficient. New equipment increases the output of each worker and thereby speeds up production. However, if demand begins to wane, companies do not need to produce as much and therefore have less need to spend on capital improvement.
Softness in the economy has pressured demand, and another way International Paper is adjusting to the slowdown is by putting off buying any new color printing presses this year. Cost-conscious customers are more likely to opt for less expensive black and white print on their packaging, decreasing the need for more color printers.
"Maybe they're going to be satisfied with going with a plain box this year, rather than something with three different color printing on it and a picture of their product...That impacts some of our spending needs," Weiss said.
THEORY OF RELATIVITY
Although recent data has shown a contraction in capital spending, Harris stressed that it is hovering near historically high levels. It appears weak in part because current figures are being compared to the blockbuster spending of the late 1990s, which was unsustainable.
"We're still at a very high level of investment. People get a little too obsessed about the growth," Harris said.
"The growth in investment is negative, (but) the level, its share in total production in the economy, remains at very elevated levels."
Nor do economists expect capital spending to stay depressed for long. In an effort to jump-start the economy, the Federal Reserve has slashed interest rates 2-1/2 percentage points this year, and the overnight bank lending rate is currently at a seven-year low of 4.0 percent.
"The Fed has cut interest rates dramatically. That will be the key....One of the first areas -- and I expect this to occur in the third or fourth quarter -- that we will see turn will be this capital goods area," said Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson Inc., adding that capital spending in the third quarter still could be negative even while showing signs of recovery.
Fed officials have discussed capital spending in recent speeches as well as in statements released after rate moves, emphasizing that the indicator has their attention. On June 5, Richmond Fed President Alfred Broaddus said a slowdown in demand has left some firms with excess capacity, with their output smaller than it could be.
"In the absence of an exceptionally strong near-term resurgence in final demand, which is not generally expected, it will take time to work this excess capacity down," Broaddus said. "As a result, investment in equipment may remain weak for some time, even though longer-term prospects remain good."
Another source of stimulus for the economy -- and in turn, capital spending -- should be the $1.35 trillion tax cut bill President George Bush signed into law on June 7, said Don Wainwright, chief executive of Wainwright Industries, a private St. Louis-based manufacturer of parts for trucks, cars and airplanes.
For now, Wainwright, also vice chairman of the National Association of Manufacturers, said he has cut capital spending by more than 75 percent at his 54-year-old family business. He added that Wainwright Industries, which employs about 300, has put on hold plans to buy new software and machines.
"It's frustrating, but it's been quite a ride over the last 12, 15 years. We'll get through this," he said. |
