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
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
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
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