Economic Trends
Edited by Peter Coy
No Double Dip from War
Crude oil prices have risen about 50% since the start of the year (chart). That's a drag on the U.S. economy, which is struggling to recover fully from the 2001 recession. With the increasing chance of war with Iraq, many economists say oil prices could go still higher, tipping the U.S. into the second stage of a double-dip recession. But the mainstream view is that an Iraq conflict, if there is one, will be short and successful and any oil price spike will be too brief to cause a recession.
Economists at Goldman, Sachs & Co. (GS
), in cooperation with the firm's commodity research team, recently published a report predicting that the macroeconomic impact of oil prices will be "muted under most scenarios." Goldman estimates there is a 55% probability that there will be no war. If that is so, Goldman foresees 2.4% growth in gross domestic product for the U.S. next year. In the 30% chance of a successful invasion, Goldman predicts 2.3% growth in the U.S. next year. Even the 15% likelihood of major damage to oil fields in Iraq, Kuwait, or Saudi Arabia would leave the U.S. with 1% growth next year, estimates Goldman.
Economists differ on what it would take to generate a recession in the U.S. Michael Cosgrove, the head of Dallas-based Econoclast Inc., thinks the economy would start to shrink if oil prices stayed at $40 a barrel for a month or so. Their current level is just under $30. But he thinks it's more likely that prices will fall to around $25 after a brief spike to $40 or so at the start of hostilities. David A. Wyss, chief economist of Standard & Poor's, says $50-a-barrel oil would give President George W. Bush a "W-shaped recession." He says, however, that oil prices will probably stay under control and the economy will keep growing. But if there's anything that's more unpredictable than the GDP, it's how the conflict in the Middle East will play out.
Look Who's Back in the Old Bloc
When communism collapsed in the late 1980s, the economic relationship between Russia and its client states in Eastern Europe collapsed with it. Investment dried up, and trade nearly ground to a halt. Now, ties are being re-established. Economists predict that expansion-minded Russian companies will spend up to $2 billion in the region this year making acquisitions or breaking ground on new projects. Russian trade with Eastern Europe is expected to top $17 billion in 2002 (chart).
Most of the investments are being made by Russia's cash-rich energy exporters, such as Gazprom, Yukos, and Lukoil (LUKOY
). Yukos Oil Co., for example, has just spent $85 million buying a 27% stake in a Lithuanian oil refining and transportation company. Gazprom recently spent $100 million laying a fiber-optic cable alongside the Polish section of the pipeline through which it delivers gas to Western Europe. Companies in other sectors, such as food processing and timber, are also keen to establish toeholds in Eastern Europe. But they find it harder than the energy giants to sidestep strict Central Bank of Russia controls on foreign investments.
Mikhail Brudno, first vice-president of Yukos, says that Eastern Europe is appealing because assets are cheap and the region's economies are growing relatively fast--at an average likely to top 3% this year. At the same time, as many as 10 countries--including Poland, Hungary, and the Czech Republic--are set to join the European Union within the next two years. So the Russian companies' subsidiaries there will gain unfettered access to the European Union market.
Many East Europeans aren't thrilled about the latest Russian invasion. "They don't like seeing newly rich Russian companies coming in and buying up their assets," says Roland Nash, head of research at Renaissance Capital, an investment bank in Moscow. But now that they have signed up to EU rules requiring them to open their capital markets to the world, the Eastern Europeans can't keep the Russians out.
A Chinese Wall for Economists?
As the government pressures Wall Street firms to dump their research departments, Wall Street economists could lose out as well. At many firms, economists are in the same department as equity analysts. Moreover, just as analysts are accused of being too bullish on stocks, critics have suggested over the years that most Wall Street economists have an incentive to be too bullish on growth, since belief in a rising market would encourage investing in stocks.
A structural reform that splits off research could dry up the funding for Wall Street economists, whose widely quoted views help shape the public's view of how the U.S. and world economies are faring. But the legal argument for splitting off economists seems weaker than that for stock analysts, says Milton Ezrati, senior economist and strategist at Jersey City (N.J.)-based money manager Lord, Abbett & Co. Wall Street economists have little influence over whether a deal gets done--one reason their pay isn't linked to dealmaking the way equity analysts' has been.
Research shows that Wall Street economists do have biases in their forecasts, but not the kind requiring government action. The New York Federal Reserve Bank found in 1997 that economic forecasters at securities firms tended to take more extreme views, both optimistic and pessimistic, than those at banks, presumably to get attention for their employers. "You tend to be ignored if you're not saying something very radical," observes Steven Wieting, senior economist at Salomon Smith Barney, whose economics and forecasting group is separate from the other research functions.
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Copyright 2002, by The McGraw-Hill Companies Inc. All rights reserved.
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