It's got to get better, doesn't it?
Economists look for sluggish recovery in 2002
By Rex Nutting, CBS.MarketWatch.com
Last Update: 3:41 AM ET Dec. 17, 2001
WASHINGTON (CBS.MW) -- The bad news is that 2001 was the worst year for the U.S. economy since 1991.
The worse news is that 2002 might be just as bad.
The economy, mired in a recession since March, will struggle to recover before summer. Workers, consumers, businesses and investors will feel even more pain in the next year.
"The recovery will come, but I don't think it'll be a strong recovery," said Irwin Kellner, chief economist at CBS.MarketWatch.com and the Weller professor of economics at Hofstra University.
Kellner is one of the more optimistic economists, figuring the economy will grow 1.5 percent next year.
"It'll be sluggish," said John Ryding, senior economist at Bear Stearns.
1% growth
The consensus among economists calls for weak growth of about 1 percent in 2002, according to the latest monthly survey published by Blue Chip Economic Forecasts. Their forecast assumes annual growth rates of about 3.8 percent in the third and fourth quarters.
The same 53 economists say growth for 2001 will probably come in at 1 percent.
While many forecasters are hopeful that massive stimulus from the Federal Reserve and the government, lower energy costs and reduced inventories will jump start the economy, others say that the stimulus won't do much to revive business spending.
"If you reverse the word 'outlook,' you get 'look out,'" said former Federal Reserve Vice Chairman Alan Blinder in recent congressional testimony. "Frankly, I'm worried about the downside risk."
What happened to bring the nation's longest-ever expansion to a halt? What will it take to restore the economy to full health?
Even now, a year and a half after the troubles began in the manufacturing sector and nearly two years after the stock market's peak, people still disagree about what went wrong and what's needed to make it right.
Pointing fingers
Some say Alan Greenspan raised interest rates too much, some claim Alan Greenspan raised rates too late, some blame Joel Klein for casting a chill on the technology sector by suing Microsoft, some say OPEC is to blame for raising oil prices.
And, not surprisingly, some say it's all Wall Street's fault.
This recession is unlike any other in the past 30 years. In the past, recessions have been rooted in weak consumer spending, typically induced by high interest rates that would discourage purchases of homes, autos and other big-ticket items.
As consumer demand faltered, businesses would find themselves unwanted inventories. They would cut back on new orders, production and hiring until demand returned. In the meantime, of course, some consumers would have lost their jobs, further reducing demand.
Eventually, the Federal Reserve would lower interest rates enough to spur demand, restoring growth once inventories were lean again.
That's not what happened this time. In fact, sales of homes and autos have remained strong, close to record levels. Consumers, despite the bear market, kept up their spending in 2001. There's not much hope that spending on autos or homes could lead a lasting recovery.
Real consumer spending grew about 5 percent in 1998, 1999 and 2000. It's slowed to about half that rate now. In previous recessions, consumer spending has turned negative.
Excesses
Instead of being plagued by weak demand, the current economy is burdened with too much supply.
Businesses had been investing at a furious pace, especially on the high-tech equipment needed to take advantage of the so-called New Economy and to replace old equipment that wasn't ready for the millennium.
For eight years in a row, business investment in equipment and software rose at double-digit rates every year.
The accompanying bull market in the stock market was both cause and effect of the investment boom. Capital goods industries found their sales soaring, justifying higher stock valuations.
Wall Street began throwing money at technology companies, which found themselves flush with the cash, credit lines and equity they used to buy both equipment and other companies.
At the same time, almost every sector of the economy was benefiting from the burst of productivity improvements brought on by technological and organizational breakthroughs that took advantage of computer networks, wireless communications, lasers and other marvels.
"Booms are born in depression, come of age in skepticism, mature in confidence, and die in euphoria," said Bill Martin, chief economist of Britain's Phillips & Drew asset management.
Can't miss
It seemed a new age had begun. You couldn't miss on Wall Street or in Silicon Valley.
As the euphoria mounted, investment was no longer about cutting costs, boosting profits or even adding to revenues, it was simply about not being left behind.
The Nasdaq 100 ($NDX: news, chart, profile) - ground zero for tech stock euphoria - soared 85 percent in 1998 and more than doubled in 1999.
The Goldilocks economy began to sour: The Fed boosted overnight rates six times between June 1999 and May 2000 to cool down the hot money.
At the same time, energy prices jumped as the Organization of Petroleum Exporting Countries managed to enforce a production quota cut. From lows of $10 a barrel in early 1999, crude oil prices rose to more than $30 in late 2000.
Whatever triggered the end - Greenspan or OPEC or etoys.com - the exuberance evaporated, beginning in March 2000.
Pop!
The bubble popped. Or as the bureaucrats at the Organization of Economic Cooperation and Development put it so eloquently: "A pronounced slowdown has occurred, triggered mainly by the ending of the high-tech stock-price bubble and by lower profit expectations."
The Nasdaq 100 plunged 36 percent in 2000 and is down another 32 percent this year.
Business investment collapsed soon after the stock market's first big sell off. Industrial production stalled and inventories began to pile up.
Once the pain in the manufacturing sector got bad enough, the Fed stepped in and began to aggressively lower interest rates, starting on Jan. 3, one day after a particularly bad report from the factory sector. In 11 moves, the Fed dropped the federal funds rate from 6.5 percent to a 40-year low of 1.75 percent.
Help for consumers
So far, the Fed's rate cuts have had limited impact. Stock prices are down about 15 percent, longer-term interest rates are only down 10 basis points or so, and the dollar remains strong against other currencies. Despite a massive infusion of money into the economy, financial conditions are largely unchanged from a year ago.
The Republican-controlled Congress also responded to the slump, approving a $1.3 trillion 10-year tax cut that included about $40 billion in tax cuts and rebates in 2001 to boost consumer spending.
Consumers got another unexpected bonus from falling energy prices. Just a few months after President Bush and others had warned about an impending energy supply crisis, supply began to outrun reduced demand. Oil prices fell back below $20 a barrel by November.
All the pieces are now in place for a recovery in consumer spending: Low interest rates, tax cuts, low energy prices.
"The recovery will be mild," said MarketWatch.com's Kellner. "A mild recession leads to a mild recovery." Since consumer spending hasn't fallen much, there's not much upside.
Some economists think consumer demand will slow in the coming months. Consumers are going to be hit with a big drop in bonus incomes at the end of the year, says Goldman Sachs economist Jan Hatzius. Others, of course, will cut back spending because of lost jobs or fewer hours.
Auto sales look ready to fall in the first quarter after a burst of buying in the fourth quarter. Home sales could also tumble as mortgage rates drift higher.
Factory sector
Kellner and other economists are more hopeful about an eventual recovery in the manufacturing sector.
"Many companies have inventories where they want them," Kellner said.
"Inventories are so low, that once demand picks up, that'll mean more production and employment," said Sung Won Sohn, chief economist at Wells Fargo. Sohn believes the economy will grow 2.4 percent in 2001, getting close to its potential by the end of the year.
Manufacturers are optimistic about strong growth by the end of the year. But the recovery "will be weak and meandering for the first six months of the year," said David Huether, chief economist at the National Association of Manufacturers. He sees investment rising just 1 percent for all of 2002.
With the dollar strong and foreign economies also slowing, U.S. producers can't count on exports to add much to demand, Huether said.
The strength of the manufacturing recovery depends on what Congress comes up with in a stimulus bill, said Jerry Jasinowski, president of the NAM. If there are no pro-growth tax cuts, like the elimination of the corporate alternative minimum tax or accelerated depreciation, the economy would only grow 2.4 percent instead of the 2.8 percent with the tax cuts, he said.
Capital spending
There is considerable skepticism about the effectiveness of the tax cuts to spur business spending.
The Federal Reserve threw cold water on the prospect, noting that "marked disincentives existed for many firms to make capital expenditures in the context of excess capacity, weak markets, and poor profit opportunities," according to the minutes of the Nov. 6 Federal Open Market Committee meeting.
"The pruning of excess capacity is still largely incomplete," said Stephen Roach, chief economist at Morgan Stanley, who's long argued that this recession is different in a fundamental way.
"This is actually the type of business cycle that predated World War II, spanning the late 19th and early 20th centuries," Roach said. Those 19 downturns between 1854 to1945 averaged 21 months in length.
"That means there could be a good deal more distance to travel before the U.S. economy ultimately hits bottom," Roach said.
Neither tax cuts nor rate cuts can spur investment spending before firms are ready, said Allen Sinai, chief global economist for Decision Economics. "Permanently higher sales, earnings, cash flow and expansion opportunities are necessary for business to spend aggressively," he said.
"Capital spending downcycles are usually long-lived," Sinai said.
The Fed can lower interest rates all it wants and Congress can cut taxes all it wants, but companies won't invest until they see a payoff. It largely depends on the profit outlook beyond 2002.
Corporate financial officers say they think profits will rise about 14 percent in 2002, but they are planning on cutting capital spending by 5 percent.
It'll take more than a healthy return to profitability next year to get companies to expand.
Kellner says there are five things that could go wrong with his forecast: Oil prices could rise, interest rates could go too high, the stock market could tank, profit worries could lead to more layoffs.
And terrorists could strike again.
The economy is not out of the woods yet.
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Rex Nutting is Washington bureau chief of CBS.MarketWatch.com. |
