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DECEMBER 29, 2003
U.S.: Hopes For The New Year Aren't Just Sentimental One bit of evidence: The long-awaited rebound in manufacturing For the first time in four years, the economy is heading into a new year on a solid, broadly based foundation that is generating great expectations for 2004. Will those hopes be validated? On that question, the data at the close of 2003 are undeniable: The economy's momentum is real, and it will continue to build into early 2004. In BusinessWeek's annual survey, economists project that real gross domestic product will grow 4.3% in the first quarter and 4.1% for the year. This new energy shouldn't be surprising, for two fundamental reasons. First, the economy's underlying ability to grow will always reassert itself. And second, this time around, that force was propelled by record low interest rates and massive, quickly enacted tax cuts. Indeed, one of the key lessons of 2003 is: Policy works. The push from historically stimulative economic policy is showing up right where it would be expected to, in stronger demand across all major categories. Consumers are set to post brawnier spending gains coming out of the fourth quarter than when they began the period. Tax cuts, more jobs, and increased wealth from a 10,000 Dow Jones industrial average lifted retail sales by a sturdy 0.9% in November, and those factors will help spending to overcome December's bad weather. Low interest rates are helping to keep builders the most optimistic in years as November housing starts rose close to a 20-year high. Businesses are ramping up their equipment outlays, partly reflecting new tax benefits from more favorable depreciation allowances. Companies are also scurrying to rebuild depleted inventories, as stock levels sink to record lows in relation to sales. Some of this new demand is going to imports. But U.S. manufacturers are also benefiting noticeably, with industrial production and utilization rates rising decisively in November. Plus, U.S. exporters are finally seeing foreign demand pick up sharply, a trend that should accelerate in 2004 when economies around the globe post faster growth. Moreover, despite this economic verve, the consumer price index actually fell 0.2% in November, and excluding energy and food, the core index dropped 0.1%, taking annual core inflation to a 40-year low of 1.1%. Some one-time factors were at work in November, but amid economic slack at home and abroad, the economy has plenty of room to grow without pressuring prices. PERHAPS THE CLEAREST SIGN of the economy's building momentum is the vitality in the long-depressed manufacturing sector. In November, output in U.S. factories, mines, and utilities rose 0.9%, and production in the factory sector alone jumped 1%, the largest monthly increase in four years (chart). The turnaround began last spring, but since August, factory output has grown at an annual rate of 8.7%, a three-month pace on a par with some of the best showings of the late-1990s boom. Consequently, the factory operating rate, while still at a low 73.8% in November, has been rising steadily since May.  This output rebound is what happens when a three-year bust in capital spending and a depleted stock of inventories come face to face with a sharp surge in demand. Companies find that they need either to boost their outlays on equipment and inventories or risk losing sales.The recovery in capital spending, led by tech, is boosting production of business equipment, which rose 1.7% in November. In the past three months, business-equipment output grew at rates comparable with those seen in the capital-spending boom of the late 1990s. Production of high-tech gear has been climbing all year and now stands 27.5% above its year-ago levels. AT THE SAME TIME, the need to build up inventory levels is acute. Inventories at manufacturers, wholesalers, and retailers rose 0.4% in both September and October, but they are still slightly below where they were six months ago. Meanwhile, overall business sales are up 4.6%, and an increasing number of purchasing managers says stock levels are too low. The inventory situation is even more pressing when autos are excluded. The number of cars parked on dealers' lots began to rise in early fall, prompting a new round of sales incentives. Excluding autos, the ratio of inventories to sales is at a record low, even after accounting for how technological changes have reduced the amount of inventories that businesses desire to hold. Further rebuilding of U.S. inventories will provide a boost to American manufacturing, but it also will lift the inflow of imports. The widening trade deficit will probably be a drag on growth in the fourth quarter. In October, the trade deficit of goods and services increased to $41.8 billion, from $41.3 billion in September. The trade gap began the fourth quarter well above its third-quarter average, and it could worsen further because imports are increasing at such a rapid pace. But the focus on the rising trade deficit obscures a welcome trend within the foreign sector: Exports are increasing. Foreign shipments have risen in five of the last six months, including a 2.6% gain in October. After adjusting for price changes, merchandise exports are growing this year, after plunging in 2001 and showing no growth in 2002. This turnaround in exports is another source of the momentum for the U.S. economy. IN ADDITION, to the surprise of many, housing is speeding up. Most economists had expected homebuilding to be waning by now. After all, new home sales have posted consecutive record highs for three years in a row, so it's hard to see where the pent-up demand is coming from. But it's another example of how policy works: Thanks to an accommodative Federal Reserve, mortgage rates remain low enough to keep interest in homeownership high. As a result, builders in November were the busiest they've been in almost two decades. Starts jumped for the third consecutive month, rising 4.5% to an annual rate of 2.07 million (chart). A building number above 2 million hasn't been seen since early 1984. Although pre-winter storms may have curbed some of December's activity, homebuilding in the fourth quarter is on track to increase sharply from its pace of the third quarter, adding another plus for real GDP growth at yearend.  Thanks in part to fixed mortgage rates still running under 6%, builders are fairly upbeat as 2003 draws to a close. The December Housing Market Index, compiled by the National Association of Home Builders, stayed at a high reading of 70% in December, with buyer traffic rising to 51% from 47% in November. And as long as rates and the weather hold out, housing might even add to real GDP growth in the first quarter as well.Like resolutions to stop smoking, economic optimism abounds every time the calendar turns over. But in the recent past, drags such as excess capacity or unforeseeable events like the corporate scandals have managed to short-circuit the recovery's power. Heading into 2004, however, the economy is finally well-positioned to make good on expectations that the year will be better than the one it replaces.  By James C. Cooper & Kathleen Madigan
BW MALL
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