Recession? What recession?
Published: March 8 2002 19:28 | Last Updated: March 8 2002 19:31
news.ft.com
Recoveries happen. Predicting their timing is tricky. But in the US, good economic news has come so thick and fast that even those of the most pessimistic bent now accept that the recession is over - at least for the time being.
Investors are convinced. The S&P 500 index has risen by more than 7 per cent in the past fortnight.
Policymakers are swayed by the evidence. A week after delivering a cautious report to the House of Representatives, Alan Greenspan, the Federal Reserve chairman, changed his tune, announcing to the Senate that "an economic expansion is already well under way".
Politicians are cheered. With the US economy contracting only in the third quarter of last year, Paul O'Neill, the US Treasury secretary, feels vindicated. He predicted there would be no recession and, on one measure at least, he was right.
Good data continues to flow. The US unemployment rate in February fell slightly to 5.5 per cent, confounding expectations of further job losses. After past recessions, unemployment had risen for many months before it stabilised. Productivity rose at an annual rate of 5.2 per cent at the end of last year, the third fastest pace in 18 years.
This is enough evidence to conclude the recession is at an end. The US has just endured the shortest and shallowest period of declining activity for at least 30 years. That is some record. And it is one that throws up two related questions. How durable is the recovery? And should investors flock to US assets? The grounds for caution on both questions are considerable.
Sustained recovery
There is little doubt that forecasts for US economic growth of 2-3 per cent this year look plausible now. Much of the recent downturn was caused by companies halting production to cut their accumulated levels of surplus stock. But this down-phase of the stock cycle is petering out. Companies have stabilised stock levels and some are beginning to rebuild inventories. If stock levels merely stop declining, the annualised rate of gross domestic product growth will increase by more than 2 per cent in the first quarter. And stock building should boost growth, potentially by a large amount, for much of this year.
This effect is temporary, however. A sustained recovery needs other components of economic growth to be strong.
Abundant spare capacity alongside weak profitability and continued downward pressure on prices suggests that investment will remain subdued for some time. Consumption also remains strained. Households borrowed so much in the 1990s that the debt service burden is at a record level in spite of low interest rates. So a rapid rebound in consumption is unlikely. There is also little reason to think net exports will contribute much to growth: domestic demand in the US is at least as strong as any other major economy, while imports are likely to rise faster than exports.
Long-term interest rates
Equally problematic is that each time expectations of recovery become firmer, long-term interest rates rise. After Mr Greenspan's testimony to the Senate, the yield on 10-year Treasury bonds jumped; it is now a percentage point above its trough in November, providing a further drag on rapid recovery, regardless of the Fed's actions on short-term interest rates.
If economic prospects remain modest in the medium term because imbalances built up during the boom years have not unwound, the outlook for US investments looks no better.
Equity prices may have fallen in the past two years but they remain high relative to profits and to their long-run trend. So history provides little cheer for the hopeful investor. Other factors are not encouraging either.
Sustained low inflation reduces companies' ability to boost profits through higher prices; the stagnant equity market can increase costs, as payment though stock options is no longer attractive to employees.
The US has the additional concern that it relies on foreign capital to shore up its yawning current account deficit. Were that to dry up, the dollar and US returns for foreign investors would tumble rapidly. It happened in the mid-1980s, when the dollar was equally strong. It can happen again.
All this casts something of a cloud over the optimism being projected by Messrs Greenspan and O'Neill. After a sharp boost from stock rebuilding, the US economy seems poised for modest growth at best. Investors have little reason to think that the double-digit returns of the 1990s will regularly recur henceforth.
But there is a silver lining. The current prospect may seem dull, compared with the excitement of the 1990s. Nevertheless, if the US economy can grow at modest, sustainable rates for the next few years, it will in itself be a considerable achievement. |
