Should We Worry About a Budget Deficit?
October 4, 2001
Mitchell J. Held,
Managing Director
U.S. Equity Research
Salamon Smith Barney
There's talk that another shot of fiscal stimulus is imminent. Congress continues to debate not so much the size but the structure of what ultimately should prove to be a fiscal spending package approximating 1% of GDP. Chances are that the Federal government now will run a deficit of as much as $25 billion in the fiscal year that began on Monday. Listen to the bond market and worries about a potential acceleration in the inflation rate are beginning to fester. Are they right to fester?
Well anything has a right to fester but those who fear a near-term acceleration in inflation probably are worrying prematurely. The first half 2001 slowdown, combined with the likelihood of a second half 2001 GDP annualized decline of 1% or more, has created a lasting amount of excess capacity, not only here but around the world as well. And because the underlying growth rate was boosted in the 1990s by enhanced productivity, excess capacity is greater than it has been in the past given the performance of GDP we've seen so far this year.
This means that there's plenty of room for stimulus, be it from monetary or fiscal policy sources. The truth is, it's coming from both. And that's fine as economic, political and social needs all seem to dictate. Assuming we're correct, the economy will be growing at or above its underlying growth rate by this time next year.
But the faster the economy grows, the faster excess capacity will be utilized. And at some point, probably well into 2003 at the earliest, questions will then (properly) be raised on the need for the economy to slow. There are two ways to do that, through monetary policy and higher interest rates, or through fiscal policy with higher taxes and/or restrained spending. In the aftermath of the Gulf War, a similar situation faced Congress and a newly elected Clinton Administration. Taxes were raised, Congress showed the compunction for spending restraint and the burden of a tighter policy was borne by fiscal, not monetary policy, to the benefit of the financial markets.
In our view, however, the need for fiscal restraint is tomorrow's worry, not today's. The events of three-plus weeks ago have created an immediate need for stimulus of every kind - fiscal, monetary and a push from abroad as well. Over the near term, it's imperative that lawmakers grease the economy's skids, less the adverse psychological impact in the aftermath of September 11 be joined by severely adverse economic consequences.
Jobless Claims
During the week ended September 29, initial claims for unemployment insurance rose 71,000 to 528,000, the highest level since a strike in the auto industry lifted claims to 539,000 at pone point during the summer of 1992. The increase was much greater than expected. The four-week moving average, at 453,500, is at its highest level since late 1991. Continuing claims, reported with a one-week lag, rose 133,000 to 3.410 million, their highest level since August 1992.
While higher than generally expected, the rise in claims should not be too surprising given the large number of layoffs announced over the past few weeks. There's little doubt that labor markets will soften further. The consumer's reaction to these layoffs will be crucial to the economy's performance. Our best guess is that consumers will recoil initially, but that the combination of aggressive fiscal and monetary policy easings will return them to their spending ways within the next six months or so.
Tomorrow, the employment report for September will be released and apparently, the attacks of September 11 will have little influence on the data. The BLS will clarify things when the report is released. We look for another 100,000 drop in payrolls, a one-tenth percentage point rise in the unemployment rate to 5%, a modest 0.2% wage gain and a sharp, 1% decline in total hours worked.
NAPM Non-Manufacturing Index
There are surveys and there are surveys and then, there are statistics. When asked how the economy is, some surveys and polls suggest that both American consumers and businesses have been in agreement that things are good. Indeed, many surveys published in the aftermath of the terrorist attacks in New York and Washington showed an improvement in consumer confidence and the maintenance of big-ticket buying plans. Respondents seem reluctant to say that they are being unpatriotically cautious.
Yesterday, the National Association of Purchasing Management released the results of their September survey of non-manufacturing activity. Surprisingly, the index rose to 50.2 (consistent with rising activity - okay, barely rising activity), up sharply from the 45.5 mark (consistent with declining activity) registered in August. Indeed the survey (which apparently incorporated responses from both before and after the terrorist attacks) suggested that the entertainment, utilities, mining, public administration and health services sectors reported rising activity last month. This seems inconsistent with what most non-manufacturing industries are reporting.
Keep in mind that this is a subjective survey and respondents are asked to respond to the question "Is business activity 'higher,' 'lower' or 'the same' as it was last month?" Essentially, the index is calculated by taking the percentage of those reporting "higher" activity and one-half of those reporting "the same." It's then seasonally adjusted. Furthermore, the survey began in July 1997 and while it has been thoroughly back-tested, in reality, no one is sure how it is "supposed" to act in a recession.
True, the equity market took heart from the non-negative NAPM non-manufacturing survey. We certainly do not want to get in the way of the market taking heart from anything it wants to. But harder, true number-crunching data needs to be obtained before anyone should jump to the conclusion that we may skirt recession. |
