Not All Doom and Gloom

Jan. 1, 2001
By now, news of an economic slowdown is no longer news. Corporate earnings are down, inflation is rising, the housing market has slowed, and the U.S.

By now, news of an economic slowdown is no longer news. Corporate earnings are down, inflation is rising, the housing market has slowed, and the U.S. foreign trade deficit, as of September 2000, stood at $34.3 billion.

Most economists say some or even all of those were likely to happen after the economic boom that characterized much of the 1990s. The speed at which the slowdown is occurring, however, has caught much of the country off guard.

"A couple of months ago you couldn't sell people on a slowdown, and now everyone is calling it a recession," said David Wyss, chief economist at Standard & Poor's in New York. "We are seeing a definite slowdown."

The year 2000 marked the record 10th consecutive year of economic expansion, despite slumping auto sales, manufacturing and construction late in the year. Economic growth also slowed to 2.4 percent during the summer, its weakest pace in four years.

Housing construction, typically a leading indicator of economic activity, fell 10.5 percent during the summer and through the first 10 months of 2000 was down 4 percent from a year earlier, according to the Commerce Department. Similarly, home sales through October dipped 1 percent to 777,000 from 785,000 for the same period in 1999.

Stock and finance Banks have reported a rise in loan losses and cut back on credit beginning with the new year. Charlotte, N.C.-based Bank of America stated it would write off $870 million in loans because of "further weaknesses in the economy," while First Union Corp., also based in Charlotte, noted its loan losses would increase this year.

Corporate profits were noticeably down during the latter half of 2000, forcing analysts to re-evaluate their earlier predictions of increased profits for U.S. corporations in 2001.

"Profits were initially projected to grow about 15 percent," said Joe Cooper, research manager at First Call/Thomson Financial in Boston. "But now it has been scaled to 10 percent, so they've already scaled it back a third. And they could go further."

Cooper attributed the expected fall in company earnings this year, as well as lower profits in late 2000, to increased energy costs, increased federal interest rates and decreased consumer spending, all of which adversely affect the economy.

The broader stocks on the stock market, representing some of the largest and most profitable firms in America, grew at an average of 25 percent a year from 1996 to '99. In 2000, the growth of those stocks was 6 percent lower, said David Greenlaw, an economist at Morgan Stanley Dean Witter in New York.

He added that the characteristic increases in household income and spending cash around the home in general during the last few years, called the wealth effect, might not be there with the recent falls in company earnings and profitability. Those falls have a greater effect now on Americans who have invested heavily in the stock market.

"The wealth effect has been a powerful force driving the economy," Greenlaw said, adding that a recent federal survey revealed that more than 50 percent of Americans have some exposure, i.e., vested interest, in the stock market. In 1988, only 30 percent of Americans were invested in the stock market.

"With a slowdown in the economy, spending will more closely track personal income," Greenlaw said.

Since 1996, Greenlaw said, real consumption growth has risen an average of about 4 1/2 percent a year while real disposable income has risen only 3 1/4 percent. Consumers have compensated by borrowing more money and digging into investments with little concern for the potentially leaner times now here, he said.

Interest rates For the 12-month period ended in October 2000, the Consumer Price Index rose 3.4 percent. During the first 10 months of 2000, the CPI rose 3.6 percent, compared with 2.7 percent for all of 1999. That, coupled with an increase in the average wage of production workers (to $13.89 per hour as of October, according to the Bureau of Labor Statistics), spurred widespread concerns over inflation after a decade of economic growth.

The Federal Reserve responded by raising the short-term interest rate on overnight bank borrowing six times by a total of 1.75 percent since June 1999. That rate stood at 6.50 percent before the Fed's Dec. 19 meeting to address the subject further. Those rate raises, combined with a flatter stock market and a strong U.S. dollar, have contributed to the slowing of the economy.

The Fed's preoccupation with extinguishing a potential inflation-fueled fire raised concerns that the reserve might have gone too far and in fact might be stimulating an outright recession. Those concerns were heightened in November when Fed chairman Alan Greenspan acknowledged that the economy was "appreciably" slowing. In early December there was speculation he would cut interest rates to curb the slowdown.

Unemployment projections seemed to back up his words.

The jobless rate was at a 30-year low of 3.9 percent in October. It has hovered from 3.9 percent to 4.1 percent since October 1999, but the New York-based Bond Market Association's economic advisory committee, made up of leading Wall Street economists, projects the unemployment rate will rise to 4.2 percent in 2001.

"I don't think it's going to move appreciably higher," said Brian Jones, an economist at Salomon Smith Barney in New York. "An increase in unemployment and reduced consumer spending usually go hand in hand, but I'm not all that worried about it (happening)."

Consumer spending, First Call's Cooper said, has dropped especially among those heavily invested in the stock market.

Silver lining Despite the economic slowdown, the United States by many accounts figures to maintain a steady if less than spectacular growth rate last seen in 1995.

Morgan Stanley's Greenlaw predicts the economy, measured by real gross domestic product, will grow at about 2 z percent, as was the case in 1995. From 1995 to '99, the economy grew at a 4 percent clip before nearing 5 percent in late 1999 and early 2000.

Robert Parry, president of the Federal Reserve Bank of San Francisco, said he does not think the world's largest economy is on the brink of a recession. Instead, he said the economy shifted to a more sustainable growth rate during the last few months of 2000, backing Greenlaw's projection.

Similarly, the BMA said expansion will continue through 2001 but at a slower pace than was predicted in mid-2000. The association's economic advisory committee predicts the gross national product will grow by 3.5 percent compared with 4.1 percent in 2000.

Manufacturers stand to benefit, particularly if the euro continues to gain strength against the dollar. In December, a BMA committee report predicted the euro would rise from 88 cents to "just below parity" by the end of 2001.

Standard & Poor's Wyss said the strong dollar likely will keep the country saddled with a foreign trade deficit, but a stronger euro will make it easier for manufacturers to sell product overseas.

"(A strong dollar) puts a lot of pricing pressure on U.S. manufacturers, and that's good in that it holds down inflation but bad because it squeezes earnings," he said. "But we are seeing a strengthening of the euro, and if that continues, it will benefit manufacturers."

Decreased activity in the housing market, Wyss added, is not "as big an issue as it used to be," and sales during recent years were uncharacteristically high. In that respect, real estate agents knew it wouldn't last and weren't caught off guard, he said.

Despite concerns over falling stock prices and earnings, dipping home sales and rising unemployment rates, calling the current slowdown a recession is clearly, in the eyes of many economists and financial experts, a reach.