Business Outlook: U.S. Economy
U.S.: This Political Shock Won't Upset the Soft Landing
But a prolonged squabble could unnerve the markets--and consumers
Oil shock? Market shock? Up to now, neither has been strong enough to wreck the economy. Now let's try political shock, as the U.S. fumbles its way toward electing its 43rd President. Will the failures of the electoral system bring down the economy in the next few months? Don't bet on it.
First of all, people don't seem to mind the election delay, judging from a New York Times/CBS poll. Indeed, if households and businesses didn't flinch at a shutdown of the federal government or even an impeachment, then a little delay in deciding on the next President is unlikely to ruffle their feathers. Once the winner is determined, the economic outlook will return to business as usual--meaning, back to the fundamentals.
So far, those basics add up to nothing worse than a soft landing, almost exclusively as a result of the less accommodative financial conditions wrought by the Federal Reserve. Stingier banks, tighter credit markets, and costlier equity financing are already starting to temper the recent booming growth in both consumer spending and business investment in new equipment. In particular, households bought fewer cars in October, and overall retail sales began the fourth quarter on a soft note (chart).
Political shock itself only becomes a problem if it seriously affects the stock market, which has become a key determinant for the strength of domestic demand in this expansion. Most likely, any damage to stock prices will be transient. And so far, the electoral mess only seems to be exaggerating ongoing market concerns over profit expectations in a slowing economy.
Moreover, the expected post-election gridlock in fiscal policy will more likely do more good than harm. In the absence of any major fiscal stimulus, the markets know that the Federal Reserve will remain firmly in control of the economy.THE FED SEEMS CONTENT that the slowdown is leading toward the desired soft landing, although policymakers are still not convinced that the threat of rising inflation is abating. After hiking its overnight rate from 4.75% in June, 1999, to 6.5% in May, 2000, the Fed at its Nov. 15 policy meeting continued to leave interest rates unchanged. The Fed admitted that the economy could slow to a pace even below its long-run trend, generally taken to be 3.5% or so. However, it said that the slowdown in demand to date has not been sufficient to alter its view that the risks in the outlook are weighted toward conditions that could generate higher inflation.
The Fed faces a rough road, though. Because consumer spending is the source of the excess demand that is straining the economy's productive resources, and because monetary policy is a blunt instrument, the Fed must tame consumers without killing off capital spending, which has been a key engine for growth and has provided key benefits for productivity and inflation.
So far, policymakers are succeeding. Thanks chiefly to Fed tightening, the wealth effect on consumers is diminishing, yet there are no signs of any sudden retrenchment in capital spending. The broad Wilshire 5000 stock index is down 12.6% from its March peak, and that measure of equity value is no higher than it was a year and a half ago (chart). At the same time, labor markets remain solid, and income prospects still look bright. Election uncertainty won't last long enough to disrupt spending patterns.EVEN SO, THE CONSUMER OUTLOOK is where political uncertainty could come into play. Household outlays had grown two percentage points faster than income, because of the wealth effect from ballooning stock prices. Market volatility this year--which started long before Americans heard the terms "pregnant chad" and "hand recount"--has curbed the wealth effect, and consumer spending is already slowing more in line with income growth. A continuation of that trend is the main reason to expect slower overall economic growth in 2001.
The immediate risk is that prolonged political uncertainty, especially in the form of a major legal challenge to the Florida results, will roil the financial markets. That could further erode consumer confidence and spending. A key piece of data to watch will be the Conference Board's November consumer confidence index, due out on Nov. 28.
Nonetheless, even the recent mild consumer slowdown comes at an inopportune time for retailers gearing up for the important holiday-buying season. Retail sales in October posted a tepid 0.1% gain from September, and the growth rate from a year earlier is slowing. Clothing shops, department stores, and building-supply businesses posted gains that were offset by softer sales elsewhere.
Car buying fell back noticeably in October, and excluding autos, retail sales rose 0.4% in the month. Unit sales of cars and light trucks dropped to an annual rate of 16.7 million from 17.8 million in September. However, manufacturers are offering new incentive programs in November, which should lift sales.HIGHER ENERGY COSTS are another depressant on consumer spending, and the impact seems likely to continue a while longer. On Nov. 14, OPEC decided against boosting oil production, fearing that prices could fall sharply next year as economic growth slows. Crude-oil prices averaged almost $33 per barrel in October, and in mid-November they are running about $34. That's up nearly $10 from a year ago, an increase estimated to cut about 1/2 of a percentage point off economic growth.
While holiday sales may not be booming, they are not likely to be extremely weak. Consider that retail sales began the quarter well ahead of the third-quarter average. Excluding cars, sales are already growing at a 3.7% annual rate vs. last quarter, when they increased at a 5.8% pace from the second quarter. Based on preliminary data, overall real consumer spending seems on track to rise at an annual rate of about 3% this quarter, although weekly surveys of buying activity in early November look relatively soft so far.
At the same time, outside of autos, the manufacturing sector appears to be stabilizing after a soft period this summer. Industrial production in the factory sector was flat in October, but most of the industrial sector's weakness has been concentrated in the auto industry in recent months, reflecting both temporary and fundamental factors (chart). Excluding motor vehicles, manufacturing output increased a solid 0.5% in October, putting nonauto production well above its third-quarter level.
The bottom line is that, yes, the economy is slowing as the Fed's efforts to pull off a soft landing bear fruit. And little indicates that this nation's ongoing political shock will rattle the economy, especially since the fundamentals remain quite sturdy. The Greenspan Fed pulled off a soft landing in 1994, and it will very likely succeed again in 2001--regardless of how long it takes to elect a President.By James C. Cooper & Kathleen MadiganReturn to top