Amid the Uncertainty, Business Balks at Spending
By RICHARD W. STEVENSON and DAVID LEONHARDT
The New York Times
9/22/02
Investors are getting creamed on Wall Street. Consumers are nervous. New jobs are scarce. Japan, the world's No. 2 economy, is stuck in a deflationary bog and Europe remains lackluster, providing scant hope for exporters.
But more than anything else, the course of the American economy this year and into the next rests with corporate managers like Calvin A. Campbell Jr., chairman of the Goodman Equipment Corporation, a locomotive maker in Bedford Park, Ill.
At a time when corporate earnings are dismal across the country, Mr. Campbell and his counterparts in all kinds of industries face risks that extend from the ripple effects of a possible war with Iraq to an uproar from shareholders demanding new standards of corporate governance.
The choices they make in that difficult and uncertain environment about fresh investments in factories, computers, telecommunications equipment and other capital goods will go a long way toward determining whether the United States continues limping along at a modest rate of growth or restores itself to robust economic health.
"From the perspective of the economy, uncertainty is the enemy of growth," said Richard Berner, chief United States economist at Morgan Stanley. "What you see in the marketplace is a high degree of risk aversion."
Mr. Campbell, for one, is certainly cautious. He is waiting until he gets a clearer sense of demand from customers before investing in new cranes, computer software and other equipment. And right now, the mining companies that pay up to $400,000 for his locomotives remain reluctant to spend and are paying off previous purchases more slowly. "If people can delay, they delay," Mr. Campbell said. "There's a lot of caution, a lot of pessimism."
Mr. Campbell's experience is common. After recovering slowly for much of this year, capital spending now appears to be weakening. If that trend continues, the economy will have to muddle along on the backs of consumers who, despite their jitters, have proved willing to keep spending. Without a rebound in business investment, economists say, the economy is unlikely to rebound sharply. But many corporate executives, seeing a lot of dark clouds on the horizon, are in wait-and-see mode.
"If you're a corporate executive in this environment, you face a higher level of uncertainty — and more sources of uncertainty — than you have in your career," said Robert D. Hormats, vice chairman of Goldman Sachs International.
"You face the uncertainty about additional acts of terrorism," he said. "You face the uncertainty about a war with Iraq, with all the implications that holds for energy prices and a broad impact on the economy. You face a greater degree of scrutiny of corporate governance, which makes people more cautious in how they run their companies. And then you face all the questions about where the economy is going."
The effects are showing. After picking up somewhat over the summer, the economy appears to be slowing again. The manufacturing sector stopped growing in July and August, according to a survey of managers by the Institute for Supply Management. And 3.6 million people received unemployment benefits in the first week of September, the highest number since June, according to the Labor Department.
There are pockets of strength. Low interest rates have fueled strong automobile sales and have set off waves of mortgage refinancings, putting more cash into the hands of consumers and keeping housing and related industries vibrant.
But there are also plenty of reasons for continued concern. At the top of the list is the stock market's slide, which destroyed nearly $420 billion of wealth last week alone. The decline is hurting companies' ability to raise money and is forcing individual investors to rethink everything from next year's vacation plans to their retirement timetables.
Companies are also struggling to maintain profit margins, let alone raise prices. Occupancy rates at the Loews Hotels chain, for example, have returned to levels reached before Sept. 11, 2001. But with travelers more worried about costs than they were a few months ago, Loews is selling more discounted rooms than it did in the past.
"We were definitely seeing cautious optimism prior to a month ago," said Charlotte St. Martin, the company's executive vice president for marketing. "We have seen a bit of a slowdown."
Even companies with healthy profit increases do not credit the domestic economy. On Thursday, FedEx said operating income in its most recent quarter rose 20 percent, versus a year earlier, but cited overseas business and a cost-cutting program as two of the main reasons. FedEx has cut capital spending and revamped operations to use fewer workers.
"We're cautiously optimistic" about the rest of the year, said Michael Glenn, executive vice president for market development, offering the closest thing to exuberance in corporate America today.
Now, with President Bush having made clear his intention to confront Saddam Hussein through military force if necessary, government officials, economists and executives are adding unsettling factors to their economic and financial planning.
One school of thought holds that the economy would benefit from a war, because government spending on the military and domestic security would surge, giving the economy a fiscal jolt to go along with the one being delivered by the tax cuts Mr. Bush signed into law last year.
But there is a broader consensus that a war, assuming that it goes well and remains restricted to Iraq, would be neutral or even negative for the economy.
From the White House to the Federal Reserve to corporate headquarters across the country, there is general agreement that a war could affect the economy through four main channels: a sharp rise in oil prices, a further steep fall in the stock market, a decline in consumer confidence and a surge in the federal budget deficit.
For now, the official line from Washington asserts that any war will not have to be a major economic event.
Although Iraq's invasion of Kuwait in 1990 and the American military action the next year helped send the economy into a mild recession, federal officials say there is no reason to assume that the same thing will happen this time. Since then, the economy has changed.
As Alan Greenspan, the Fed chairman, told Congress this month, the United States uses less oil relative to total economic output than it used to. As a result, the economy is less susceptible to an oil price spike if Middle East supplies are disrupted.
Mr. Greenspan acknowledged that previous recessions had been preceded by run-ups in oil prices, but he said that there was little reason to think the pattern would repeat, especially if a war is no longer than the conflict in 1990-91. "I don't think the effect of oil as it stands at this particular stage is large enough to impact the economy unless the hostilities are prolonged," he said.
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Other analysts differ, however. Should the war spread to Saudi Arabia or become regionwide, oil prices could easily rise above $40 a barrel from their current range of $25 to $30. Such an increase, they say, would affect both businesses and consumers in the United States and around the world.
In a country of S.U.V. drivers, an oil price shock accompanied by 24-hour coverage of hostilities in Iraq could be enough to put a crack in consumer confidence and weaken what has been the main pillar of the recovery so far: consumer spending.
For now, consumers remain remarkably resilient. L. Douglas Lee of Economics From Washington, a consulting firm, noted that with wages rising at an annual rate of 4 percent and inflation at less than 2.5 percent, real incomes are growing for most people. The combination of rising income and the 2001 tax cut has allowed many people to keep spending while increasing their savings.
"The consumer is in pretty good shape, unless you think the labor market is falling apart," he said.
Some analysts, though by no means all, think it is. In a report to clients last week, John Youngdahl, an economist at Goldman Sachs, warned of "accumulating evidence that business firms have begun another round of labor restructuring and cutbacks, in response to earnings disappointments and a further tightening of broad financial conditions over the summer."
On Tuesday, for example, the Charles Schwab Corporation said it would dismiss about 1,800 employees over the next two months. Schwab had already eliminated about 7,000 jobs, more than one-quarter of its work force, since early 2001. This month, Lucent Technologies announced that its sales were even weaker than forecast, and analysts said the company might have thousands more layoffs in coming months.
Aside from the apparent increase in layoffs, Mr. Youngdahl said, "there continue to be statistical signs that job creation is abysmally weak, and thus the reabsorption of unemployed persons into the work force is difficult."
Consumers would also be hurt, financially and psychologically, by a continued drop in stock prices. Although many analysts say investors will probably remain nervous as long as there is talk of war, military success could bring a quick-relief market rally. "Uncertainty is bad for markets," Mr. Lee said. "But there's an adage that says, `Sell the rumor and buy the bullets.' It's often been proved true in the past."
A war could also influence markets by raising the federal budget deficit, which is already expanding faster than Congress or the administration anticipated a few months ago.
White House officials say they have not budgeted any particular amount for a war. In any case, they say, the United States can afford it.
Mitchell E. Daniels Jr., the director of the White House's Office of Management and Budget, said one cost estimate floated earlier by the administration — of a maximum of $100 billion to $200 billion — was almost certainly too high.
He said the only guideline was the Persian Gulf war in 1991, which cost $60 billion, or about $80 billion in today's dollars. Four-fifths of the cost was paid by the allies.
At those levels, war spending would amount to less than 1 percent of gross domestic product, not enough for major economic effect.
It would, however, be enough to make a substantial if presumably one-time difference in the budget deficit, which is projected to total $165 billion for the fiscal year that ends on Sept. 30.
The uncertainties related to a war, economists said, must be viewed against the backdrop of an economy already struggling past excesses of the bubble economy of the late 1990's.
The full array of uncertainty is clearly visible to Mr. Campbell of Goodman Equipment. On Thursday, he attended a lunch at an executives' club in downtown Chicago, where candidates running for governor in Illinois had come to speak. The discussion at his table quickly turned to the stock market, and a few of his peers wondered if the Dow Jones industrial average would return to its previous peak in the next 10 or even 20 years.
A few weeks ago, after Mr. Campbell had used the word "fair" to describe the state of his business, he recalled that another executive said to him, "That's the most optimistic word I've heard in a long time."
Hearing that kind of pessimism, Mr. Campbell says he wants to see four or five months of good economic news before he begins investing large amounts of Goodman's money. Every time people have begun to become more optimistic over the last year or so, he said, a new reason for worry has sprung up, be it terrorism, corporate scandal or, most recently, the possibility of war.
"People gained confidence," he said, referring to this spring, "and now they've lost it."
He added, "If we do go to war, I think it's going to set us back from an economic standpoint."
Like Mr. Campbell at Goodman, many manufacturing executives, who depend on capital spending for profits, are trying to sort through the news from Wall Street and Washington as they set budgets for 2003.
"It's the most indeterminable economy I've ever lived in," said Tony Raimondo, chief executive of Behlen Manufacturing, in Columbus, Neb., which makes metal buildings and grain dryers. "One month, it's up and you're a little excited. The next month, it's as bad as it's been."
Behlen's consumer business, which sells farming equipment that typically costs a few hundred dollars, is thriving. The division that builds factories and other structures is struggling, though it has picked up compared with last year. In a good month, he said, the unit will sell $3.5 million of products. Last year, it sold just $2 million of goods in some months. Now, sales have improved to just above $2.5 million.
But that has not made Mr. Raimondo confident enough to proceed with a plan to expand a factory in the Northwest. "I wish I could tell you," he said with a sigh, that "we're not part of the problem."
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