[FORTUNE] What could go right ?

From: Udhay Shankar N (udhay@pobox.com)
Date: Fri Mar 16 2001 - 22:47:43 PST

Fortune being unfashionably optimistic ? Maybe TEOTWAWKI *is* at hand...


What Could Go Right?

It's scary. It's a downer. But the slowdown won't last forever. In fact,
it may even be ending now. While it's easy to find examples of truly
frightening past recessions and depressions, it's very hard to find any
scary historical parallels that really fit the situation of the U.S. in 2001.
Monday, March 5, 2001
By Justin Fox

The U.S. economy has ground to a halt. That's certainly not news to
  anyone at this point. What you and the rest of the world are dying to
  know is just when America--that powerful, high-tech, and usually
  reliable engine of global growth--will get moving again.

We won't bury the lead: The answer is soon. In fact, the recovery may
  have started already.

Yeah, yeah, yeah, there are risks and there are uncertainties. The
  course the economy takes tomorrow depends on choices made today by
  executives drawing up sales forecasts, investors sorting out portfolios,
  shoppers rolling carts through the Home Depot. Sudden shifts in business
and consumer confidence can wreak havoc with the best-laid economic

In other words, a lot can go wrong, especially in a land of heavily
  indebted consumers, high trade deficits, and a recently collapsed stock
  market. But the case for what could go right is simply more compelling.

This is partly just a matter of looking at the economic data. To most of
  us (and that would include most people on Wall Street), the main
  impression left over from the recent barrage of often contradictory
  numbers on things like retail sales, inventories, and consumer
  confidence is one of utter confusion. But to a veteran data-watcher like
  Mark Zandi at Economy.com, there is a pattern to be discerned--and a
  fairly encouraging one at that. December may have been a month of
  contraction, but the economy seems to have grown in January, while the
  early weeks of February were mixed. Says Zandi: "The economy is
  struggling, even sputtering, but it's still probably growing."

Another, slightly better known data-watcher, Federal Reserve Chairman
  Alan Greenspan, gave a similar assessment to Congress in mid-February.
  While Greenspan's abilities as an economic seer are at times overhyped,
  he does have one big advantage over everyone else in the forecast
  business: He actually has the power to make his forecasts come true. The
  Fed's sudden, sharp rate cuts in January flooded the U.S. economy with
  money. You can count on your fellow Americans to find ways to spend it.
  That alone is reason to believe in a comeback.

Finally, there's this: Because the U.S. economy is so big and
  complicated and so danged hard to grasp, those who attempt to forecast
  its course often rely on historical parallels to tell their story. While
  it's easy to find examples of truly frightening past recessions and
  depressions, it's very hard to find any scary historical parallels that
  really fit the situation of the U.S. in 2001. That doesn't mean that
  something bad can't happen this time around; it just means that glib
  references to Japan in 1989 or the U.S. in 1929 don't really tell us
  much of anything--especially since the reality of U.S. economic history
  is that, most of the time, everything has worked out okay.

It all adds up to a cautiously optimistic scenario for the coming
  months. Maybe an itty-bitty recession, but probably not. Definitely a
  recovery sooner rather than later.

This sort of sanguinity isn't exactly fashionable just now. Remember how
  boosters of the 1990s new-economy boom refused to see it as anything but
  an epochal, paradigm-shifting, rule-breaking golden age? Well, many
  observers of the 2001 new-economy bust can't seem to accept that we're
  simply watching the good old business cycle at work. Instead, it's the
  end of an era, retribution for times of excess, the beginning of the new
  Dark Ages.

Actually, that kind of rhetoric has been mostly restricted to
  journalists and other amateurs; few professional economy-watchers are
  willing to employ quite such purple prose. Instead--and this says
  something about the enduringly primitive state of business-cycle
  economics--most of the talk in forecasting circles is about letters:
  specifically, L's and V's and U's and W's.

An "L" is the scariest scenario, one in which the U.S. economy spends
  the next few years in a post-boom hangover with little or no economic
  growth. Sort of like Japan in the 1990s, except that even the grimmest
  of pessimists don't see the U.S. economy still stuck in a malaise ten
  years from now. A "V" is the cheeriest scenario, in which growth
  restarts almost immediately--possibly even averting an official
  recession, which requires six straight months of economic contraction. A
  "U" anticipates an ugly recession and a slower comeback. As for the "W,"
  it's good news if you think we're in the second half of the letter (with
  the first half being the 1998 global financial crisis and subsequent
  Fed- stimulated comeback) but bad news if you think we're in the first
(with the second being the recession brought on by the Federal Reserve
  when its current easing leads to raging inflation).

Among economic forecasters, the consensus is that we're looking at a
  "V." That doesn't mean a whole lot, because forecasters tend to have
  trouble nailing down economic turning points. But a quick look at recent
  U.S. economic history seems to support the "V" hypothesis. The only
prolonged or repeated recessions in the post-World War II era have come
  in times of sustained high inflation, when the Federal Reserve raised
  interest rates and kept them up in an attempt to wring that inflation
  out of the economy. The hints of inflation that the Fed decided to fight
  last year were mere wisps compared with the inflation of the 1970s and
  early 1980s; and the Fed's 1999 and 2000 rate hikes were playful pinches
  compared with the forceful tightenings of earlier days.
That doesn't mean there are no longer any risks. The standard economic
  problems of the post-war period involved overly expansionist central
  banks, deficit-racked governments, and an overregulated private sector.
  And guess what? Those problems have largely been solved. As a result,
  we'll probably have new problems to deal with. Or very old problems. One
  way to look at it, as Princeton University economist Paul Krugman put it
  two years ago in the pages of Foreign Affairs, is as the "Return of
  Depression Economics."

Krugman's main concern is this: In an era of low inflation, free trade,
  and deregulated financial markets, a central bank like the Fed might no
  longer find it so simple to kick-start an economy that has fallen into
  recession. He isn't the only smart economist talking this talk. In
  January, former Treasury Secretary (and former Harvard economics
  professor) Larry Summers scared a few folks at the World Economic Forum
  in Davos, Switzerland, with his observations that the current U.S.
  downturn reminded him a lot more of the prewar variety than anything
  seen since.

If this analysis is correct, it may mean the Fed and other central banks
  need to shift their focus from inflation fighting to recession fighting.
  To a certain extent, that appears to be what the Fed under Greenspan has
  done during the past three or four years. This is less straightforward
work than merely hiking rates to keep the consumer price index down, and
  surely the Fed will make a hash of it one of these days. But to go from
  there to arguing that the Great Depression or even the Japanese "L" is
  upon us--something neither Krugman nor Summers has done, but several
  bearish Wall Street forecasters have--is a misreading of both past and

It's a misreading because virtually every U.S. economic downturn before
  World War II was brought on by some sort of financial breakdown. Not
  just a stock market crash but a credit crunch in which perfectly solvent
  businesses and individuals suddenly became insolvent because no one
  would lend them money anymore. That's what happened in the Great
Depression of the 1930s, it's what happened to several Southeast Asian
  and East Asian economies in 1997, and it's sort of what happened to
  Japan in the 1990s (the difference being that Japan averted an all-out
  financial collapse but is nonetheless plagued by banks that won't lend
  and consumers who won't spend).

That's not going to happen in the U.S. of 2001. It's not just that the
  Federal Reserve and the federal government have the resources at their
  disposal to stave off a full-blown financial crisis and know how to use
  them. It's also that there isn't any sort of financial breakdown under
  way from which we must be rescued.

The closest thing to a breakdown was what happened to the market for
  high-yield, high-risk corporate bonds (a.k.a. junk) in December. After a
  difficult autumn, the market for new issues effectively shut down for
  the month, the longest drought experienced since 1990, when it shut down
  for an entire year. If this market freeze-up had lasted much longer, a
  lot of established but cash-eating cable operators and telecom companies
  would have been in big trouble. But then the Fed lowered interest rates
  Jan. 3, and the market came roaring back. In the entire fourth quarter of
2000, corporations sold $4.4 billion in new high-yield debt in the
  U.S., according to Merrill Lynch. In the third week of January, issuance
  totaled $5.1 billion; in the fourth week, $5.2 billion. Things have
  slowed down since, and high-risk startups of the sort that were
  harvesting money by the bucketload a year ago still can't raise a cent,
  according to Martin Fridson, chief high-yield strategist at Merrill. But
  a junk market meltdown clearly has been averted.
As for other debt markets, they're functioning just fine, thank you. The
  mortgage market is booming, mostly due to refinancings prompted by
  sinking interest rates. Consumer credit growth has slowed but not
  stopped. Banks are seeing profits fall, but those profits have been so
  high for so long that few are in any kind of financial trouble.

So if there's no financial crisis, what exactly has been making the
  economy so wobbly? Paradoxically, it may have something to do with the
  very high-tech boom that drove the prosperity of the 1990s. For one
  thing, emerging technology businesses are by nature volatile: New
  technologies wipe out old ones; too many companies jump into promising
  new fields; investors get overexcited and bid up stock prices too high.
  That has been the case with the semiconductor, software, and PC
  industries since their inceptions--it's just that in the past their share
of economic activity was so tiny that their occasional wipeouts
  didn't much matter to anybody else. Now they do.

The sheer screeching rapidity of the slowdown (from 5.6% GDP growth in
  the second quarter of 2000 to 1.4% in the fourth) can also be traced in
  part to the products that tech companies have been selling to the rest
  of corporate America. Thanks to their massive investments in ERP
(enterprise resource planning), CRM (customer-relationship management),
  and SCM (supply-chain management) software, and other groovy
  technological tools with impenetrable acronyms, American companies were
  able to sense the slowdown and react to it much more quickly than they
  could have in the past. The problem is that when thousands of companies
adjust their expectations downward all at once, the cumulative effect is
  even worse than what any of their snazzy new technological tools could
  have predicted, resulting in lots of companies getting stuck with excess
  inventories precisely because lots of companies were trying to avoid
getting stuck with excess inventories. (For more on this, see "Glut
  Check" in First.) When businesses get stuck with excess inventories,
  they tend to cut back on production until those inventories go away,
  which is one of the reasons recessions happen.

Greenspan talked about this in his February testimony to Congress,
  suggesting that while these new rapid-response techniques have helped
  bring on the slowdown, they may also lead the way out. And sure enough,
  the next day new data came out showing that business inventories had
  virtually stopped growing in December--a sign that the worst of the
  inventory correction could be behind us.

All of which may well mean that the most important question of the
  moment may not be whether there will be a recovery soon, but how strong
  it will be. The answer to that will also decide one of the great debates
  of the 1990s: Are American businesses, and American workers, really using
new information technologies to become significantly more
  productive? If productivity is on a long-term upswing, then there's room
  for lots more economic growth and lots more profit growth at American
  corporations. If, however, the strong productivity gains of the past few
years have mostly been the result of cyclical factors and data quirks,
  we could be looking at a return to the days of 2% GDP growth and tough
  times for corporate profits.

The debate among economists over productivity has been so drawn out and
  complicated that it's really not worth getting into here. The Fed's
  Greenspan is among those who argue that something real is afoot, and
  he's been winning converts in recent years. If the productivity gains
survive this year's downturn, he'll win over a lot more--and the U.S.
  economy won't have to worry about any U's, W's, or L's.

((Udhay Shankar N)) ((udhay @ pobox.com)) ((www.digeratus.com))
      God is silent. Now if we can only get Man to shut up.

This archive was generated by hypermail 2b29 : Fri Apr 27 2001 - 23:14:17 PDT