The specter must spook the administration-in-waiting. It would threaten the new president’s popularity, play havoc with budget planning and, possibly, create conflicts with Alan Greenspan’s Federal Reserve. For the record, few economists yet forecast a recession, and Greenspan last week hinted that a weaker economy might allow the Fed to cut interest rates. Still, the irony of the present situation remains: the economy’s greatest strength–over-powering confidence–could become its biggest vulnerability, if the modest slowdown punctures the prevailing optimism. That could trigger a chain reaction of crippling cutbacks in consumer and business buying.
Consider how hyperconfidence has shaped the boom. Since 1992, consumer spending (on everything from cars to computers) has outraced personal income. People have borrowed, cashed in stock profits or stopped saving. The personal-savings rate–saving as a share of after-tax income–has fallen from almost 9 percent to roughly zero. Suppose that Americans, worried by rising debt or falling stock prices, increased their saving. If the savings rate rose only to 2 percent, that would lower consumer spending by about $140 billion: fewer SUVs, appliances and mobile phones sold.
Corporate investment faces a similar danger. Here, too, there’s been a binge. From 1995 to 1999, investment spending rose 54 percent. Companies bought computers, installed communications networks and built factories and warehouses. In manufacturing, there’s already idle capacity. In the third quarter, industry operated at 82.2 percent of capacity compared with 85.4 percent at the peak of the 1980s’ business cycle. Indeed, investment has already suffered from a drying up of new capital. In 1999 and 2000, nearly $100 billion of bonds have gone into default, reports Moody’s Investment Services. Companies haven’t been able to meet payments. Naturally, “New Economy” companies now find it harder to borrow.
In short, a slowdown could feed on itself–and the slowdown is now unmistakable. Last week General Motors said it would build 1.3 million vehicles in the first quarter of 2001, down 14 percent from the level in 2000. Intel, the world’s largest computer-chip maker, said that weak demand for personal computers would mean flat or lower revenues in the fourth quarter. Or consider broader economic indicators:
Alone, these small setbacks aren’t alarming. Indeed, the Fed intended them. Since mid-1999, it’s raised interest rates six times to prevent runaway spending and low joblessness from increasing wage-price inflation. Slackening sales and housing starts may mean only a temporary pause in production–as stores and home builders trim surplus inventories–and then a “soft landing”: tempered growth with tame inflation.
Among economists, this remains the dominant view. Because the economy has grown so rapidly, it has ample room to decompress. “Why should we have a recession?” asks David Wyss, chief economist for Standard & Poor’s. “The stock market’s tanking–but it’s still way up over the past several years. And there’s nothing else on the horizon, except maybe another oil-price shock, that’s really very threatening.”
Maybe.
But for the new president, there are two problems. First, even a soft landing may seem fairly bumpy compared with the smooth ride of recent years. Macroeconomic Advisers, a major forecasting firm in St. Louis, expects the economy to grow slightly less than 3 percent in 2001. But “it will feel pretty bad. Corporate profits are flat, and the stock market is down,” says economist Chris Varvares. Car and truck sales drop 1.2 million units, and housing starts slip an additional 4 percent. Unemployment is predicted to rise to 4.5 percent by early 2002.
The second problem is that the standard forecasts ignore the major danger: a collapse in confidence. American consumers are assumed to spend in line with income growth–not faster (as in recent years) or slower (as would occur if people increased their saving). Put differently: the savings rate stays at about zero. To predict a rise in saving would mean a jolt to consumer spending that would, almost certainly, lead to a recession. While confidence survives, prosperity becomes a self-fulfilling prophecy. People spend because they believe, and because they believe, prosperity endures.
To ask whether the confidence is justified is to raise profound questions about the boom. Does it stem from new technologies that create higher rates of productivity growth ( output per hour) and faster advances in wages and profits? If so, confidence may be rooted in reality. People can spend more now because they’ll be richer later. Similarly, high stock prices reflect a sensible expectation of hefty profits tomorrow. But what if the boom has been at least partly a classic episode of speculative excess–overpriced stocks, doomed investments in dubious start-ups and people’s spending beyond their means? Then productivity gains will prove fleeting–more the result of high demand than high technology–and the boom will end grimly.
If the answers were obvious, the questions wouldn’t be necessary. No one grasps that better than Greenspan. In recent months he’s conducted a subtle campaign to sustain confidence. Although the Fed has raised interest rates, he’s given repeated speeches extolling the promise of new technologies. The aim seems to have been to minimize the impact of pessimistic news (higher rates, a weaker stock market, higher oil and natural-gas prices) on confidence by painting a reassuring picture of the long-term prospects. This is deft maneuver, at best: to restrain the economy on the one hand and to talk it up on the other.
The new president must hope that he succeeds. For now, confidence is at a high level, even if it’s wobbling slightly. In the NEWSWEEK Poll, 45 percent of respondents expect their financial situation to improve in the next year and only 6 percent expect it to get worse–results about the same as in March. But if the climate turns, the new president could reap a whirlwind of layoffs and bankruptcies. Bill Clinton’s relation with the economy was dreamlike; his surprises were mostly pleasant and popularizing. For his successor, it could be just the opposite.
