Eugene Coyle wrote:
>Now it seems he can't let go of the idea that things will be roaring again
>soon.
For the record, Comrade Coyle, here's what I had to say in LBO #97,
written in May. The only way I've changed my tune since then is
towards greater gloom.
People who call for global recession every other week don't deserve
kudos when they turn out to be right.
And now I'll really go quiet.
Doug
----
WHAT NEXT?
Maybe the fifth time is the charm. The Federal Reserve has cut
interest rates five times this year -- one of the most densely packed
easing trends in its history. Having spent 1999 and much of 2000
tightening, with the intention of cooling the U.S. economy down, the
Fed is busily trying to undo its own earlier work and reverse its
sinking course of the last half year.
There's been a lot of downbeat economic news over the last few
months. U.S. employers shed 276,000 jobs in March and April, and the
ranks of the unemployed grew by 466,000. (The numbers don't match
because they come from two different surveys: the first comes from a
survey of employers, and the second, from one of households.) More
seems on the way: big firms have been announcing thousands of planned
layoffs, first-time claims for unemployment insurance have risen, and
people are telling pollsters that jobs are getting harder to find and
that their general sense is that the economy's getting worse. Usually
these signs are harbingers of a slower economy and rising
unemployment. Some firms, particularly in high-tech, are reducing
workweeks without laying people off, meaning that the official job
numbers may be understating the damage to incomes and lives.
Other indicators are looking weak too: GDP growth has been sagging,
companies are cutting back on investment plans, and state tax
collections are coming in under projections, suggesting things could
be a bit worse than official stats make them appear, And the bad news
isn't just of domestic origin: growth in the European Union, one of
the world's brighter spots, is also slowing (with Euroland industrial
output falling sharply in March, and British business confidence
falling sharply in April), and Japan is producing little other than
bad economic news.
But the U.S. news isn't all doomy. Our proprietary RecessionIndex�
(well, not really; we stole the idea from The Economist), which
showed a scary spike when graphed in issue #96, is now rolling over,
much as it did after the 1987 stock market crash and the 1998 Russian
debt default, two earlier recession scares that passed in a few
months. This index, which counts the number of newspaper articles
containing the word recession, has proved more reliable at spotting
recessions than many conventional indicators. Unemployment insurance
claims fell back a bit in early May from April's near-recession
levels. And consumers are still spending -- not robustly, for sure,
but they're not padlocking their wallets, as they would be in a real
recession.
Q&A. So are we on the leading edge of recession? Dodging a bullet? Neither?
It's always hard to analyze the real world in the present tense;
reality rarely follows familiar scripts. So it's a bit much to assert
that the U.S. economy is playing hard to read these days -- when is
it ever easy? But still it feels harder than usual, because this
looks to be no ordinary business cycle. In the textbook post-World
War II business cycle of the sort that prevailed through the early
1980s, expansion would lead to "overheating," which meant shortages,
supply bottlenecks, and rising inflation. Markets would get alarmed,
the Fed would push interest rates higher, and the higher borrowing
costs would slow down the economy, led by interest-rate sensitive
sectors like housing and autos. (They're interest-rate sensitive
because, unlike food, people usually have to borrow heavily to
purchase them -- though the unemployed and indigent have been known
to borrow to buy food.) As the economy slowed, firms, noting a pileup
of unsold goods in their warehouses, would throttle back on
production, lay off scads of production workers, and this would slow
the economy further. Facing higher borrowing costs and sagging
markets, firms would also cut back on their capital investments. At
some point, after all the boom's "imbalances" had been corrected, the
Fed would grow pleased with its work, start cutting rates, and the
economy would recover from its swoon.
Political spin. There's also a more political take on the business
cycle, and one that's far more relevant to recent his tory than the
textbook case presented above. In a classic 1943 essay, "Political
Aspects of Full Employment," the Polish economist Michal Kalecki
explored the reasons why economic policymakers would never tolerate
an unemployment rate approaching zero for long:
"Indeed, under a regime of permanent full employment, the "sack"
would cease to play its role as a disciplinary measure. The social
position of the boss would be undermined, and the self-assurance and
class-consciousness of the working class would grow. Strikes for wage
increases and improvements in conditions of work would create
political tension."
And that would mean the loss of "discipline in the factories" and put
"political stability" at risk. So when mainstream economists,
financiers, and central bankers worry about "overheating" and even
"inflation," it's really this fundamental power relation they're
talking about.
But don't take a long-dead economist's word for it -- take Alan
Greenspan's. Several times during the late 1990s, Greenspan worried
publicly that the "pool of available workers" was running dry. What
he meant by that is graphed on p. 4 -- and as the graph shows, the
pool was running quite dry. The dryer it ran, the greater the risk of
"wage inflation," meaning anything more than minimal increases.
Productivity gains took some of the edge off this potentially dire
threat, said Greenspan, and so did "a residual fear of job skill
obsolescence, which has induced a preference for job security over
wage gains" -- the threat of the "sack," as Kalecki put it, still had
its sting. Workers were nervous and acting as if the unem ployment
rate were considerably higher than the 4.1% it's averaged since the
be ginning of 1999. But even this fortunate confluence of events
wasn't enough to calm a worried central banker, because as Greenspan
put it with characteristic wit, if the pool stayed dry, "significant
increases in wages, in excess of productivity growth, [would]
inevitably emerge, absent the unlikely repeal of the law of supply
and demand."
Which is why Greenspan & Co. raised short-term interest rates by
about two points during 1999 and the first half of 2000. There was no
sign of a serious inflationary threat -- with much of the world
economy flat on its back, it was one of the last things to worry
about -- nor were there any signs of rising worker militancy. But
wages were creeping higher, and the threat of the sack was losing
some of its bite. As the nearby chart shows, the share of respondents
to the Conference Board's monthly survey declaring jobs to be
"plentiful" reached an all-time high of 56% last July -- as the share
calling them "hard to get" reached an all time low of 10%. Those
numbers have since returned to a range that Alan Greenspan probably
finds much more congenial.
Equilibrium? But will they stop there? That seems to be what the Fed
would like -- a bit more slack in the labor market (meaning a bit
more fear in the hearts of workers), without a recession. Whether
they'll get that is hard to say.
While there's little doubt that the tightening cycle that began in
1999 brought about this slowdown, the way it happened was a bit
unusual. The rise in interest rates was fairly modest, and by itself
probably wouldn't have been enough to bring down the real economy.
But it burst the stock market bubble and put an end -- whether it's
temporary or permanent we don't know -- to the cybertopianism of the
late 1990s. That euphoria, backed by some of the easiest financing
conditions in human history, fueled a gadget-buying spree with few
precedents. Convinced the boom would last forever, both new firms and
established ones bought computers and communications equipment that
many of them now regret (those, that is, that are still in business).
That machinery has been thrown into reverse: euphoria has been
replaced by pessimism, and easy finance by a harsher regime. Surveys
report weak investment plans and much-lowered expectations for the
e-future. Trade journals and slick magazines now run cover stories
exhorting readers that the net still matters. The once limitless
stream of free money from venture capitalists and new stock offerings
for high-tech startups remains dry; less visibly, the credit markets
have dried up too. Bondholders and bankers are talking tough with
existing borrowers, and are extending credit only to the worthiest of
new borrowers (i.e., those least in need of loans). While the mass
death of dot.com's is mostly behind us, the shakeout in the
telecommunications sector is far from over.
Profit shortage. The Fed is rightly concerned about cutbacks in
present and planned investment spending. In the announcement
following its April easing decision, after expressing satisfaction
that firms have been running down excess inventories and that retail
sales and the housing market were holding up decently, the central
bank worried that "capital investment has continued to soften and the
persistent erosion in current and expected profitability, in
combination with rising uncertainty about the business outlook, seems
poised to dampen capital spending going forward." It reiterated this
concern in the announcement following the May easing decision,
agonizing that "investment in capital equipment ... has continued to
decline," and that "the erosion in current and prospective
profitability, in combination with considerable uncertainty about the
business outlook, seems likely to hold down capital spending going
forward."
There are several reasons for this: profits, the main source of
investment funds, are sagging; the financial markets, the source of
supplemental funds (though nowhere near as important a source as most
people think) are treating mendicants ungenerously; and prospects for
future profits, the main reason for making investments, are less than
inspiring.
The Fed is deeply concerned about the profit picture. Reuters
reported that on the morning before the Fed sprung its April surprise
on the markets, an unnamed governor phoned researchers at First Call,
a firm that analyzes corporate profit prospects, to ask about the
outlook, especially for high-tech companies. Fed officials had long
been consulting regularly with First Call -- with contacts ranging
from regular weekly phone consults to requests for special detailed
studies -- but the early morning call was unusual. Apparently nothing
changed for the better in the profit picture in the weeks after that
decision, because the Fed refilled the easing prescription.
Weaker capital spending is bad news for economic growth, but the Fed
is worried about it for longer-term reasons, too: it's come to love
the reported productivity boom of the last few years -- reasoning
that it's kept profits up and inflation down -- and fears it may fade
if companies stop spending liberally on high-tech gadgetry. The Fed
is right to be worried; the future of the U.S. economic "miracle" is
at stake.
There's plenty of reason to be skeptical about the extent and
importance of the widely reported (and widely celebrated)
productivity boom of the late 1990s. The reasons for skepticism are
too complicated for this space -- for details, see Doug Henwood's
forthcoming book, A New Economy? But the story in a few words is
this: a careful reading of the official stats suggests that much of
the productivity pickup was the result of heavy investments in
high-tech equipment. Paul Krugman wrote a famous piece in Foreign
Affairs in 1994 in which he argued that the East Asian "miracle"
wasn't as miraculous as it seemed, because it was the product of
throwing resources at the economy: investing very heavily, and
pressing ever more workers into service, rather than working smarter
(better education and training for the workforce and improvements in
organization and management). He drew a parallel with a classic
critique of Soviet economic growth (familiar to many of those who
remember the Soviet Union) -- that it was unsustainable because it
was so resource-intensive. Something like that happened in the U.S.
in the late 1990s, and that something has now stalled.
One sign of that stalling: personal computer sales have been
declining for the first time in the industry's 20-year history. But
it's not just PCs; John Chambers, chair of Cisco, the formerly
high-flying maker of routers for the Internet and internal corporate
networks, said recently that the slowdown in sales of info tech
equipment "may be the fastest any industry our size has ever
decelerated." Citing competitive pressures and rapid technical
change, the industry and its huge flock of gabbling consultants and
promoters are convinced that this will be a brief pause before it's
off to the races again -- and maybe they're right. It's always been
that way, at least as long as anyone can remember. But as the old
Wall Street saying goes, trees don't grow to the sky. Of course,
standard lefty pessimism, which tends to see every downturn as an
overture to the Big One, is probably at least as misplaced as
standard American boosterism, but it also seems likely that the tech
binge of the late 1990s won't return any time soon.
LUV song. But we're back to the question from 1,700 words ago: if no
boom, what next?
Debate on this issue boils down into a letter game: will the course
of the economy be like a V (short, sharp decline followed by a strong
recovery), a U (a more protracted version of the V), or an L (a long
stagnation)? At this point, the V seems least likely; the usual
leading indicators are suggesting stabilization, but no imminent
recovery.
As was noted in the last issue, one key to whether the Fed's easing
medicine was working is the behavior of the stock market. The first
couple of casings were received blandly; the market drifted lower
into early April. It's since turned around, and there are even signs
of speculative exuberance returning.
And the Fed hasn't been alone in its generosity: around the world,
there have been over 75 central bank casings since December. An
important dissenter from this indulgent mood has been the European
Central Bank (ECB), which is publicly worrying about inflation, and
apparently, as the new kid on the central bankers' block, is eager to
advertise its firm re solve to the world. It's only cut rates by a
quarter-point, which is as good as nothing. Maybe they're right that
Europe's long period of economic underperformance has come to an end,
and that the Continent doesn't need stimulative policies. Or maybe
they're hanging tough, to soften up European workers for wage and
public spending cuts. Europe aside, 75 global casings are nothing to
sneeze at, nor are five domestic rate cuts in the U.S. The safe bet
would be that the casings will do the trick, and even if there's no
quick reignition of the boom, things aren't likely to get much
worse, either.
Underpinning the optimistic view is the persistence of consumer
spending in the face of all the bad news -- the consumer-as-hero
narrative, which has plucky shoppers resisting the nay-sayers and
rescuing the economy from the jaws of recession. The less optimistic
interpretation is that consumption will be the last nut to crack --
that the supply-side recession (led, as it was, by cutbacks in
investment and employment rather than consumer spending) will work
its way over to the demand side in another month or three. Layoffs
will begin to bite, and the still-employed will get nervous, lock up
the VISA card, and maybe even put some money in the bank. Work by
economists at Goldman Sachs offers some support to this view. They
built a model that forecasts consumer spending based on several
standard inputs -- changes in unemployment, consumer confidence,
inflation, and the like. Actual consumption is coming in well ahead
of the levels predicted by the model. That could mean the model is
wrong, as models often are -- but it does offer some evidence for the
whistling past the graveyard thesis. Should this change, the
consequences could be severe -- a demand-side drop as sudden and
sharp as the supply-side one of several months ago. But that hasn't
happened yet.
An old rule of thumb in economics known as Okun's Law (named after
Arthur Okun, who served on the Council of Economic Advisors in the
1960s) holds that for every percentage point change in GDP growth,
there's a corresponding 0.4 point change in the unemployment rate.
So, a slowdown in growth from the 4.5% average that prevailed for the
last three years to the current 2% range should cause unemployment to
rise nearly a full percentage point, towards 5% by yearend (which
would put another 700,000 people out of work). Or, looked at another
way, it would take growth close to 3.5% to keep unemployment from
rising. So, barring formal recession, the unemployment rate is likely
to drift higher. But to get growth up to 3.5% would require a
reversal of the investment cutback, and that's not right around the
corner.
The Wall Street consensus is that the Fed is getting its way; easier
money will bring the economy back to life in a few months. That seems
too easy. It's hard to believe that one of the all-time great stock
market bubbles, which enabled one of the great capital investment
booms in modern times, could end in a brief slowdown, after which
it's back to the races once again. The L-scenario -- which, despite
its mild appearance would mean job losses, debt defaults and other
financial strains, and fiscal problems for states, localities, and
even the federal government, and nasty spillover effects in Latin
America and other regions dependent on exports to the U.S. -- looks a
lot more likely. And then there's the possibility that almost no
one's thinking of, that 70s show, stagflation.
When the 1960s productivity boom -- which everyone thought at the
time to be permanent -- ended, inflation began its decade-long
ascent, and growth rates slipped and unemployment rose. Almost no one
thinks that's likely right now, but who said that reality ever
matches mass expectations?
