| BUSINESSWEEK ONLINE : OCTOBER 16, 2000 ISSUE | ||||||||
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| BUSINESS OUTLOOK
U.S.: The Economy's Big Disconnect Consumers are still spending like crazy, even as U.S. factories slow down Looking at the latest numbers, it's hard to believe that the consumer sector and U.S. industry are part of the same economy. Consumers this quarter are once again fearless in their spending, splurging on cars, houses, and other goods. Manufacturers, meanwhile, appear hapless. Production outside of the high-tech industries is struggling to rise, and payrolls are falling. The gap in the goods-producing sector is astounding. Real consumer spending on manufactured items is up 6.5% over the past year, but the production of consumer goods has risen only 1.5% (chart). Moreover, production capacity in the nontech 90% of manufacturing has all but stopped growing. What's filling the gap? Imports. Looking ahead, this disconnect figures formidably into the outlook. For one thing, the ongoing drag on the industrial sector from import penetration has a plus side. Imports have helped to vent U.S. inflation pressures. But just how effective will that safety valve be in the future? More recently, the slowing in factory activity also reflects efforts by businesses to pare their inventories, which ballooned in the second quarter. But with overall demand now looking stronger than it did in the second quarter, helped by a rebound in consumer outlays, any inventory adjustment should be quickly accomplished. That should clear the way for at least a moderate firming up of industrial activity in the fourth quarter. WHILE KEEPING ONE EYE on factory activity, the Federal Reserve clearly is closely watching overall demand as well. As expected, the Fed left short-term rates unchanged at its Oct. 3 meeting, saying that recent data suggest that overall demand has moderated more in line with the economy's ability to produce. However, the Fed repeated its warning that the risks in the outlook remain weighted ''toward conditions that may generate heightened inflation pressures.'' The policymakers seem especially concerned that higher oil prices could lift inflation expectations, a trend that could feed into the growth of wages and salaries. For their part, consumers seem unswayed by the Fed's past rate hikes or even by higher oil prices. True, real consumer spending grew at a 3.1% annual rate in the second quarter, about half its pace during the previous year. But spending rose 0.2% in June, then 0.4% in July, and finally a large 0.6% in August (chart). If September buying rises by just 0.2%, then real consumer spending grew at a 4.5% annual rate in the third quarter. That would keep the yearly pace in spending above 5%. The fear at the Fed is that domestic demand may revive with a vengeance, creating conditions that would allow inflation expectations to become embedded into wage and price decisions, as many businesses find it easier to lift prices. That may not be true for many goods producers, but services are a different story. Inflation there is already picking up noticeably. Policymakers can take some solace in this year's weakness in the stock market, which may eventually curtail the wealth effect. The Dow Jones industrial average fell in the first two quarters. The Standard & Poor's 500-stock index and the Nasdaq were down in the second and third quarters. Households have been using the wealth gained from their stock portfolios as well as from rising home values to finance much of their spending in recent years. While real spending has risen by 5.3% over the past year, real aftertax income is up a modest 2.7%. The extra source of money--outside of current income--is why households seem to be spending more than they earn. The saving rate fell to a record low -0.4% in August. Bear in mind, though, that households have already accumulated trillions of dollars in equity gains, so the recent market weakness is not exerting much restraint so far. Stock prices will have to remain flat or decline for the wealth effect to significantly diminish. UNTIL THEN, consumers have little reason to hold back, especially if labor markets remain tight. That's why housing has remained remarkably solid despite six rate hikes by the Fed since June, 1999. New single-family homes fell 3% in August, to an annual rate of 893,000, but the dip followed an 11.8% surge in July. Sales for 2000 are running just 1.3% below their average for all of 1999, the record-high year for new-home sales. Because sales activity weakened in the spring, home construction fell off in the summer. That means residential investment was a substantial drag on third-quarter real growth in gross domestic product. With the supply of new homes for sale extremely low and with mortgage applications to buy homes increasing, however, home building may perk up later in the fall. THE NEAR-TERM OUTLOOK for manufacturers is not so sanguine. U.S. factories have not reaped all the benefits of the consumer spending spree. The nation's purchasing managers say that the industrial sector has been contracting for the past two months. The Purchasing Managers' Index stood at 49.9% in September, up only a bit from 49.5% in August. A reading under 50% means that the activity is declining (chart). According to the purchasers, total new orders, export demand, and inventories weakened last month. The drop in inventories is worth noting because inventory growth added strongly to real GDP growth in the second quarter, but that was probably not the case in the third. Factory inventories in August were up just 0.3%, following much stronger gains in June and July. Part of the industry slowdown may reflect the efforts by businesses to trim excess inventories. But the story in the industrial sector is more than just inventories. U.S. manufacturers are hobbled by increasing import penetration. The strong dollar and the global slowdown of the late 1990s enabled cheap imports to flow into the U.S. The latest revisions to the GDP data show the economy grew at a 5.6% annual pace in the second quarter. And imports accounted for a record 28% of domestic purchases of nonoil goods. Foreign producers have been a safety valve for U.S. demand by venting capacity pressures that could have led to production bottlenecks, shortages, and ultimately price increases. The losers, of course, are domestic producers of similar goods. Now, U.S. manufacturers may also have to wrestle with some slowing in exports. The purchasers' index of export orders has fallen four months in a row. All hope is not lost, of course. Tech production remains robust, and other manufacturing activity may pick up if the third-quarter rebound in consumer spending continues and if any excess inventories are quickly eliminated. For now, consumers seem to be running rings around manufacturers. But you can't judge the overall economy by looking at just consumers or manufacturers. Both hold clues to the health--and inflation potential--of the U.S. economy. By JAMES C. COOPER & KATHLEEN MADIGAN _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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RELATED ITEMS U.S.: The Economy's Big Disconnect CHART: Supply and Demand Go Their Separate Ways CHART: Consumers Get a Second Wind CHART: The Ups and Downs of the Factory Sector INTERACT E-Mail to Business Week Online | |||
