All Recessions End Eventually.
The economic news that came out in the last few months seems decidedly upbeat. Consumer confidence is edging up, the stock market seems to have weathered the Enron storm rather well and the pace of layoffs has declined. At its January meeting, the Fed held off from further cutting the interest rate, and fourth-quarter GDP growth was surprisingly positive. In some quarters, they were calling for this recession to have been over last December. So shall we bring out the bubbly from the secret Y2K stash buried in the backyard and pop the cork?
My answer is that it will be wiser to put that bottle in the refrigerator and let it chill for awhile before we pour it. "Real" recovery will take awhile to arrive, most likely by early summer, even though technically this recession may be over by late spring. And what I mean by "real" is a decent, positive rate of job growth. It will take awhile for this to happen because, even though businesses are seeing a positive up-tick in orders (and are fulfilling them), they are being cautious as far as hiring. Their mood is to either get more work out of existing workers or to make do with some part-time or temporary workers. And why wouldn't they? The technological advances of the '90s have made the current worker much more productive than before. This is what I refer to as the "dark underbelly" of productivity that lets businesses produce the same output with fewer workers. In the early '90s corporations reduced their accumulated fat from the previous two decades by cutting workers (read middle management). This process lasted for approximately two years after the recession officially ended in March 1991. However, this time around look for intensive use of existing workers before any new hiring is undertaken.
There is another important reason for businesses to be cautious, namely the uncertainty that still clouds the horizon. The economy was experiencing some mixed positive signals in August last year before 9/11 put a damper on them. There is a fixed, irrevocable cost in ramping up production and hiring workers, and this is why businesses are being cautious about their expansion plans. If one goes by the public pronouncements of CEOs of big corporations (including Warren Buffett and Bill Gates), then hiring workers at a fast clip will happen only in late 2002. They are being realistically nervous about the future, and that makes for a muted recovery in the first half of this year.
Looking at the fourth-quarter GDP, auto sales, thanks to cheap financing, accounted for the phenomenal surge in consumption. This good fortune made up for the hemorrhaging in the industrial and retail sectors where businesses drew down their inventories at a record clip. So two oddities made for a positive GDP growth, thanks also in part to surging government expenditures. However, in the coming months, auto sales will revert back to "normal" and the layoffs of the past six months will dampen other types of consumption expenditures. Thus, consumption growth will revert to its mean, and even though businesses will build up their depleted inventories, it will make for a negative to weakly positive GDP growth in the next six months. The boost from federal defense spending will be there, but state and local government expenditures will decline as the recession has impaired tax revenue collections at those levels.
However, looking at the current flood of liquidity and the expectant fiscal boost, the situation is ripe for a strong recovery in the summertime. The only "if" is whether we have any more confidence-shattering acts of terrorism at home. This factor will help keep oil prices down to a range of $18 to $20 a barrel. Coupled with productivity increases, these factors will keep inflation very low, which in turn will convince the Fed to leave the rates unchanged until late fall.
The 10-year bond rate will be in the 5.2 percent range in the coming few months and will rise to be near 6 percent once the recovery takes hold. Government budget deficits are the new reality. This will dampen the housing market and the refinancing activity that put money into the pockets of consumers last year when stock market returns were abysmal. This did prop up the consumption side of the GDP equation, a sort of positive wealth effect, but may have also generated its own problems in the form of misuse by consumers to increase their debt load. This is one negative we will have to deal with in the coming year, and, like Enron's accounting, the damage will be known only after the horse has bolted from the barn.
This brings me to another important issue regarding the health of the stock market. After the dot com bubble burst, it was presumed that the worst was over for the stock market. Enron's debacle has again brought into focus the over-exuberance of the '90s. The workhorse of economics the net present value concept was an innovation in accounting in the 1920s. Then we had the crash of 1929 followed by the miserable '30s. This time around, it seems to be a clear case of excessive financial jugglery. Whether it will be followed by a miserable decade or not is too early to tell. I hope that the Ponzi-type behavior was limited to a few firms, as economies usually don't suffer in the long run in the case of outright fraud. They do, however, suffer miserably if fraudulent practices are adopted as fundamental principles. I hope Enron was an aberration and not the trend.
Rajeev Dhawan, Director of the Economic Forecasting Center
