Mort Zuckerman
A question of confidence
jewishworldreview.com -- HOW confident do you feel about the economy? A great deal may turn on your optimism and resilience. The economic boom of the last five years was surprising and unprecedented. So, too, was the onset of the current slowdown, which occurred almost without warning. First came a sustained energy price shock, then a $5 trillion collapse in stock-market values. Most recent has been a plunge in capital spending–down from a 21 percent positive growth rate to a negative 4 percent rate in just nine months. Capacity utilization has fallen below 80 percent, its lowest rate in eight years.
Excess capacity has now caused corporate earnings to tumble, leading many corporations to seek profitability through layoffs, lower outputs (to reduce inventory), and reduced capital investment. Business had borrowed heavily to finance the investment boom, imposing high fixed costs for interest payments and depreciation, making a profit squeeze unavoidable.
None of this is fully understood. Nobody knows whether this is a garden-variety Old Economy inventory cycle, or a more serious New Economy collapse caused by overinvestment in plant, equipment, and high tech, with the multiplier effect of declining capital spending. The latter puts the economy at risk of a longer and deeper recession, to purge the excesses built up during the boom phase.
Double whammy. Remarkably, consumer spending, so far, is stable. This is due, in part, to the fact that over 80 percent of jobs are in the cyclically stable service sector. It also helps that more families today benefit from dual incomes. But now we're also seeing the collapse of temporary jobs and a rise in overall unemployment–both at rates that in the past have been harbingers of recession.
And that's not the worst of it. The hope that continued consumer demand and a diminished drag on the economy from inventory liquidation would lead to a recovery is proving to be just that–hope. The key issue now, then, is how consumers will spend in a climate of retrenchment and decline–especially with gas prices spiking. Last year, consumers borrowed to maintain their intense buying pace. If we revert from last year's pattern to a more traditional behavior of saving, say, 5 percent of disposable income, that would take some $350 billion–or 3.5 percent of GDP–out of the economy. This would aggravate the 1.5 percent drop in GDP we've already seen as a result of the falloff in capital spending. Such a double whammy, on the heels of the $5 trillion hemorrhage in stock values, could well push us into a recession longer and deeper than anything since the end of World War II.
Everybody, understandably, is looking to the Fed to save the day. The Fed bears some responsibility for the slowdown, given the record rate at which the money supply was reduced last year. It has responded with four interest-rate cuts in over three months this year, combined with one of the fastest quarterly expansions in money-supply aggregates. But the effect of cutting rates may be limited. Banks have lots of problem loans, caused mainly by the tech slump. They have tightened lending as a result. Business, on the other hand, faced with shrinking confidence and excessive inventories, may stay on the sidelines, no matter how cheap money gets.
The good news? Housing sales and prices have gone up while equities have gone down. That's contrary to the typical recessionary pattern, and the economy typically does not go into a serious downturn when this occurs. Housing should get a boost from lower mortgage rates–if they come. The tune we whistle in the dark is that interest-rate cuts will jump-start the economy by lowering borrowing costs, goosing the stock market, and making U.S. exports more competitive by lowering the exchange value of the dollar. Perversely, none of this has happened. The dollar is up, and mortgage and interest rates have pretty much stayed stable.
The key factor is confidence. If people lose it and snap their wallets shut, the downward spiral of investment, profits, and employment will only accelerate.
What to do? Since we can't put much trust in the effects of lower tax rates at this time, the Fed has no choice but to continue its cutting of interest rates to avoid the risk of accelerating the feedback effects of a potential fall in household spending. John Maynard Keynes once famously said, "In the long run, we are all dead." Wrong. In the long run, we will all flourish. In the short run, we may all have a near-death experience. We live in fragile times.
JWR contributor Mort Zuckerman is editor-in-chief and publisher of U.S. News and World Report.
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