Comments: Lawrence Goodman
Managing Director, Globalecon LLC
How bad will the recession be in terms of its depth, breadth, and duration? Importantly, how does this downturn differ from those in the past, and how will those differences affect how this recession will play out?
The most troublesome part of this recession will be its duration and that adverse business consequences will be felt in virtually every sector of the economy. Manufacturing was the first sector to enter recession as far back as November '00.
The most extensive difference between the present recession and other Post-War downturns relates to the hangover from overinvestment in technology coupled with higher risk aversion coincident with the attack on the US. For example, investment in equipment and software doubled coincident with NASDAQ mania. By '00, investment in equipment and software doubled to 12% of GDP from a relatively constant rate of 6% of GDP over the period 1982 -- 1992. The unprecedented large dual thrust of monetary and fiscal policy stimulus will also radically alter the course of the recovery, with the most immediate impact being auto purchases slated for '02 being front-loaded into the last quarter of '01.
Capital spending has borne the brunt of this slowdown/recession. Can the economy mount any meaningful recovery without a significant pick up in capital spending? What are the influences underlying your outlook for business investment next year?
A renewal of business investment will unequivocally lead the recovery -- albeit somewhat muted -- into '02. Two extraordinary factors will create an environment where business investment becomes the driving force behind renewed activity into '02. First, inventory depletion in the US economy has been absolutely astonishing with the latest -$60 billion decline likely to give way to an even more impressive downward adjustment in Q4. These factors will set the stage for a business investment driven expansion into '02. Second, the investment overhang is largest in the technology and communications sectors (as evidenced in the response to the previous question). Fortunately, the technology cycle excluding communications is more independent from overall economic fluctuations and rapid depreciation makes inventories stale in record time paving the way for recovery into Œ02.
Consumer activity will fall short of sparking renewed growth, as unemployment continues to mount. Likewise, trading partner demand for US products will also remain limited, as a resumption of growth abroad will lag that in the US. Tax cuts and direct spending outlays will help, but remain of secondary importance relative to the private sector.
The Fed has lopped off 450 basis points in 11 months. What are the signs that easier policy is working its way through to the real economy? Is there some structural blockage, or should we just be patient? What kind of headwinds are policymakers up against?
In a World of instant gratification and on the heels of a unprecedentedly long expansion, recent history presses for an immediately favorable and visible response to monetary stimulus.
In fact, a successive ease in monetary policy over the last 12 months has actually been quite important in keeping the consumer alive through much of the year, with cracks only evident into the summer. Lower mortgage rates and auto sales speak to the favorable impact on the economy of easier money. For example, the 30-year fixed rate conventional mortgage will likely average 7.2% in '01 relative to 8.3% in '00. Likewise, stellar automobile sales in the middle of a recession can be traced to the Board of Governors rather than the Boards of GM, Ford or Chrysler. The latest macro data clearly reflect an ease in monetary policy with motor vehicle and parts retail sales up a whopping 26.4% in October and personal consumption of durable goods up 13.8% during the same month.
Nonetheless, impediments to growth will provide for a below average recovery from recession. They include 1) a widening budget deficit and its impact on long-term interest rates, 2) a front-loading of automobile purchases in the last quarter of '01, and 3) extremely low rates of capacity utilization. The US budget will continue to deteriorate and by the end of next year surpluses in prior years will be view as cyclical anomalies rather than the present declines being attributed to simply an economic slowdown. Budget deterioration will lead to intensification of pressure for higher long-term interest rates, even as a few more Fed cuts are in the cards. This will boost the overall cost of finance and moderate the rebound in investment. Auto incentives will reach limits. Excess capacity will likely remain abundant in many sectors with capacity utilization at a low witnessed last in 1983.
Copyright 2001, Bloomberg L.P.
